The Kelly Criterion

If only everything in finance sounded as cool as “The Kelly Criterion,” which is also known as “the Kelly strategy,” “the Kelly formula,” and “the Kelly bet.” The Kelly Criterion is a formula used by investors (and gamblers!) to figure out how to use their capital in each transaction to maximize long-term growth.

Here’s the formula, in all its Kelly-glory:

Kelly % = W - [ ( 1 - W ) / R ]

W - the winning probability
R - the win/loss ratio

Who likes the Kelly Criterion? Warren Buffet and Bill Gross do, which means it’s time to sit up and pay attention, young grasshoppers. Though, the formula has been criticized by some economists for not including investing constraints that some investors might face in reality.