Kelly's Formula and Money Management for Trading

Kelly Kelly's 's formu formula la and money money manag manageme ement nt for tradin trading g 文章来源:   lei123 于   2007-05-27 2007-05-27 15:42 15:42:42 :42 Kelly's formula and money management for trading

2006-06-26 09:23:07

Abstract It is a formu formula la for calcul calculat ating ing how much much to bet bet handicap handicapper per = manager manager for handicap handicap

Kelly Formula What is the Kelly criterion criterion (or formula) formula)? ? It is a formula formula for calculat calculating ing how much to bet. It assumes assumes that your objective objective is long term capital capital growth growth (gettin (getting g rich). rich). The handica handicapper pper's 's choice choice of money money managem management ent strategy strategy is similar similar to the stock market market choice between between growth growth stocks stocks and income stocks. stocks. Growth Growth stocks stocks tend to be more more volatile volatile, , but in the long term return return more profit. profit. That is because because the profits profits from growth stocks stocks are reinvest reinvested ed rather rather than skimmed skimmed off. off. Every Every reinvest reinvestment ment is a calcula calculated ted risk. risk. Therefo Therefore, re, income income stocks stocks tend to fluctuat fluctuate e in value value less, less, but also return less profit in the long term. term. Kelly Kelly betting betting is for growth. growth. It reinvest reinvests s profits, profits, and thus thus puts them at risk. risk. If your objecti objective ve is to make make small small but consistent consistent profits, profits, it may be too aggressiv aggressive e a money money manageme management nt scheme. scheme.

The Kelly's formula is : Kelly % = W - (1-W)/R where:

Kelly Kelly % = perc percent entage age of capit capital al to be put into a sing single le trade trade. . W = Historic Historical al winning winning percentag percentage e of a trading trading system. system. R = Historic Historical al Average Average Win/Loss Win/Loss ratio. ratio.

Kelly's Kelly's seminal seminal paper, paper, A New Interpret Interpretatio ation n of Informa Information tion Rate, 1956, 1956, examine examines s ways to send data over telephon telephone e lines. lines. One part of his work, The Kelly Formul Formula, a, also also applies applies to trading, trading, to optimize optimize bet size. size.

In reality reality, , I think think Kelly's Kelly's formula formula is too risky for real real money money manage management ment. . One reason is, your your trading trading size

Number_of_shares = (Kelly% * Current_Capital / starting_risk_per_unity_of_assets)/Security_Price where starting risk = maximal loss at trade(in %). Example: Current Capital - 25000$ Security Price - 50$ Kelly - 0.20 (it's calculated on the basis of the historical data) Maximal Loss at trade - 25% (it's calculated on the basis of the historical data) In this case you can buy (0.2 * 25000/0.25)/50 = 20000/50 = 400 shares During his record-breaking trading Larry Williams used the Kelly's formula where the starting risk was defined by the size of the margin per futures fontract. Thorpe recommends using % of risk within 0.5 * Kelly <= % risk < Kelly bounds.