Financial Word of the Day: Kelly Criterion

Definition of Kelly Criterion

The Kelly Criterion is a mathematical formula used to determine the optimal size of a bet or investment in order to maximize long-term growth while minimizing the risk of ruin. In plain English: it helps you figure out how much to invest—not just what to invest in—based on the odds and your expected edge.

Originally developed by John L. Kelly Jr. while working at Bell Labs, the Kelly Criterion has been used by gamblers, hedge fund managers, professional traders, and serious investors who care about one thing above all else: staying in the game long enough to win.

Why the Kelly Criterion Matters

Most people focus on returns. Smart investors focus on position sizing.

You can have a great investment idea and still blow yourself up by risking too much. The Kelly Criterion exists to solve that problem. It answers questions like:

• How much should I allocate to this opportunity?

• What’s the right balance between growth and risk?

• How do I avoid going all-in… and going broke?

At its core, the Kelly Criterion helps you optimize growth without overexposing yourself. It’s not about being aggressive—it’s about being strategic.

The Basic Formula for Kelly Criterion (Don’t Panic)

Here’s the classic Kelly formula: Kelly % = (bp − q) / b

Where:

• b = odds received on the investment

• p = probability of winning

• q = probability of losing (1 − p)

Now, before your eyes glaze over—here’s the key takeaway: The Kelly Criterion tells you what percentage of your capital you should risk on a single opportunity if you know your edge.

And that “if” is doing a lot of work.

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A Simple Example of Kelly Criterion

Let’s say you have an investment where:

• You believe there’s a 60% chance of success

• If it succeeds, you make 100% on your money

• If it fails, you lose your investment

Using the Kelly Criterion, the math might suggest risking 20% of your capital on that opportunity.

Here’s the important part:Most professionals don’t use full Kelly.

They use:

• Half-Kelly

• Quarter-Kelly

Why? Because real life isn’t a spreadsheet. Probabilities are estimates, not guarantees.

How Kelly Criterion Helps You Create More Money

The real power of the Kelly Criterion isn’t gambling—it’s discipline.

It teaches you to:

• Avoid emotional over-betting

• Scale positions intelligently

• Protect capital during losing streaks

• Let compounding work over time

In everyday language, it helps you avoid the classic mistake of saying, “This feels like a sure thing,” and then risking way too much.

Bottom Line

The Kelly Criterion reminds us of a timeless money principle: You don’t have to swing for the fences to win. You just have to avoid striking out.

Used wisely, it’s a tool for thinking better about risk, allocation, and long-term wealth building—not a license to gamble.

And that mindset alone can help you make—and keep—more money.