# Kelly Criterion > The Kelly criterion finds the bet size that maximises long term growth given your edge. Learn the formula, worked examples and why most traders use less. Source: https://learn.tradelabsai.com/risk/kelly-criterion/ Track: Risk Management · Level: Beginner · Updated: 2026-10-03 Publisher: TradeLabs AI (https://tradelabsai.com). Education, not financial advice. Cite as: TradeLabs Learn, "Kelly Criterion", https://learn.tradelabsai.com/risk/kelly-criterion/ The Kelly criterion is a formula for choosing how much of your capital to risk on a bet or trade when you know your edge. It was published by John L. Kelly Jr., a researcher at Bell Labs, in 1956. Kelly showed that betting a specific fraction of capital maximises the long term growth rate of wealth. Betting more than that fraction lowers long term growth and increases the risk of ruin; betting less gives lower growth but a much smoother ride. ## The formula For a simple bet with two outcomes: ``` f* = (b × p − q) ÷ b ``` - **f** (written f* in the formula) is the fraction of capital to bet. - **p** is the probability of winning, **q = 1 − p** is the probability of losing. - **b** is the net payout ratio: how much you win per $1 risked. For trading, a common form uses win rate and the ratio of average win to average loss: ``` f* = W − (1 − W) ÷ R ``` where W is the win rate and R is average win divided by average loss. ## Worked examples **Example: A trading strategy** Win rate 55%, average win 1.5 times the average loss. f* = 0.55 − 0.45 ÷ 1.5 = 0.55 − 0.30 = 0.25. Full Kelly says risk 25% of the account per trade. That is far more than most traders would ever consider, and for good reason. **Example: A prediction market share** You believe an outcome has a 70% chance, and a Yes share costs 60¢, paying $1. If you win, you gain 40¢ per 60¢ risked, so b = 0.4 ÷ 0.6 ≈ 0.667. p = 0.70, q = 0.30. f* = (0.667 × 0.70 − 0.30) ÷ 0.667 ≈ 0.25. Kelly suggests 25% of capital, but only if your 70% estimate is correct. If the true probability is 62%, the edge nearly disappears and a 25% bet is reckless. See [Expected Value](https://learn.tradelabsai.com/math/expected-value/). ## Why full Kelly is dangerous in practice 1. **Your edge is an estimate.** Win rates and payoffs from a backtest or a guess are uncertain. Overestimating your edge, which is common, makes Kelly tell you to bet far too much. 2. **Huge drawdowns.** Even with a correct edge, full Kelly regularly produces drawdowns of 50% or more. Few people can stick to a strategy through that. 3. **Changing conditions.** Markets change; an edge measured last year may be smaller now. 4. **Correlated bets.** Kelly for single bets ignores that several trades may lose together. 5. **Fat tails and gaps.** Real losses can exceed the assumed loss when stops gap. Overbetting beyond Kelly is especially harmful: betting twice the Kelly fraction gives zero long term growth, and more than that leads to long term decline. ## How traders actually use Kelly Most practitioners use a fraction of Kelly, commonly half or a quarter, and cap it at their normal risk limits. Kelly is more useful as a sense check than as a sizing rule: - If Kelly for your strategy is tiny or negative, your edge is too small to trade. - If you are risking more than Kelly, you are definitely overbetting. - If Kelly suggests 25% but you risk 1%, you have a large margin of safety for estimation errors. See [Fractional Kelly](https://learn.tradelabsai.com/risk/fractional-kelly/). ## Kelly and expectancy Kelly only gives a positive bet size when your expected value is positive. A strategy with negative expectancy should never be traded at any size, and Kelly makes that explicit by returning a negative fraction. See [Expectancy](https://learn.tradelabsai.com/risk/expectancy/). ## Common mistakes - **Using backtest statistics at face value** in the formula. - **Applying full Kelly** to real trading. - **Ignoring correlation** between simultaneous trades. ## Frequently asked questions ### What does the Kelly criterion tell you? The fraction of capital to bet that maximises long term growth, given your probability of winning and the payout. ### Should I use the full Kelly criterion? Almost never. Because edges are uncertain and drawdowns are severe, most traders use a fraction such as half or quarter Kelly, often capped further. ### What happens if I bet more than Kelly? Long term growth falls and the risk of large drawdowns rises. At twice the Kelly fraction, expected long term growth drops to zero. Next, learn the practical version: [Fractional Kelly](https://learn.tradelabsai.com/risk/fractional-kelly/). ## Sources - Wikipedia, [Kelly criterion](https://en.wikipedia.org/wiki/Kelly_criterion) ## Continue learning - Next lesson: [Fractional Kelly](https://learn.tradelabsai.com/risk/fractional-kelly/) - Previous lesson: [Volatility and ATR-Based Sizing](https://learn.tradelabsai.com/risk/volatility-and-atr-based-sizing/) - Related: [Volatility and ATR-Based Sizing](https://learn.tradelabsai.com/risk/volatility-and-atr-based-sizing/): Volatility sizing adjusts position size so each trade carries similar risk whatever the market's swings. Learn ATR sizing, volatility targeting and worked examples. - Related: [Fractional Kelly](https://learn.tradelabsai.com/risk/fractional-kelly/): Fractional Kelly bets a portion of the full Kelly fraction to cut drawdowns and protect against overestimated edges. Learn how much to use and why. - Related: [Expectancy](https://learn.tradelabsai.com/risk/expectancy/): Expectancy is the average amount you win or lose per trade. Learn the formula, how win rate and payoff combine, expectancy in R and how to improve it. - Related: [Position Sizing](https://learn.tradelabsai.com/risk/position-sizing/): Position sizing decides how many shares or contracts to trade so each loss stays small. Learn the formula, worked examples for each market and common mistakes. - Related: [Risk of Ruin](https://learn.tradelabsai.com/risk/risk-of-ruin/): Risk of ruin is the chance that losses drain your account beyond recovery. Learn what drives it, see simulated numbers and how to keep it low. - Related: [Expected Value](https://learn.tradelabsai.com/math/expected-value/): Expected value is the average result of a bet over many repetitions. Learn the formula, trading and prediction market examples, and why EV alone is not enough. - Related: [Kelly Criterion Calculator](https://learn.tradelabsai.com/tools/kelly-criterion-calculator/): Free Kelly criterion calculator. Enter your win probability and payoff ratio to find the full Kelly fraction, a safer fractional Kelly and expected growth.