I just finished Fortune’s Formula by William Poundstone. I’ve learned about the Kelly Criterion from various websites and books, but never knew how effective it can be. This book shows how Ed Thorp used the Kelly Criterion to manage his money in Black jack and Roulette to the stock market. The formula is odds/edge.
This is the formula from Investopedia with some explanations.
- f* is the fraction of the current bankroll to wager;
- b is the net odds received on the wager (that is, odds are usually quoted as “b to 1″)
- p is the probability of winning;
- q is the probability of losing, which is 1 − p.
The only problem with the Kelly Criterion is that it is volatile, so some people use a portion of the Kelly Criterion, such as 1/2 Kelly Criterion. I plan on using the Kelly Criterion on my individual stock investments. It will be a fractional amount of the formula. Here is a website that uses the Kelly Criterion for stock investments with multiple outcomes.