The Kelly Criterion is a mathematical formula used to determine the optimal size of a bet or investment position that maximises long-term compounded wealth growth while avoiding ruin. Developed by John L. Kelly Jr. in 1956, the formula is: Kelly % = (Win Probability × Average Win) – (Loss Probability × Average Loss) ÷ Average Win. Applied to trading, it calculates what fraction of total capital to deploy in each trade based on the strategy's edge and payout ratio. Full Kelly sizing can result in large drawdowns, so most professional traders use a fractional Kelly (typically 25–50% of the full Kelly recommendation) to reduce volatility while still benefiting from the compounding logic. The Kelly Criterion is widely studied in quantitative finance, though it requires accurate estimates of win rates and payout ratios to be applied reliably.
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