Building Automated Trading Strategies October 2018 | Page 29

follow the 1% rule and that means no trading position should be worth more
than 1% of a portfolio.
The Kelly Formula
The Kelly formula can help traders to calculate how much to risk on a single
trade position. The formula was introduced by John L. Kelly, and became
popular later by the Ed Thorp:
Optimum Size (%) = W – (1 – W) / R
Where:
•
Optimum Size (%) = percentage of capital to be put into a
single trade.
• W = The historical winning percentage of a trading system
• R = The Historical Average Profit/Loss ratio
There is also an expanded version of the formula that appeared in Thorp’s
interview in the book Hedge Fund Market Wizards 7 :
F = PW - (PL / ($W / $L))
Where:
7
• F = Fraction of capital to bet
• PW = Probability of winning the bet
• PL = Probability of losing the bet
• $W = Dollars won if bet is won
• $L = Dollars lost if bet is lost
“Generalizing the Kelly Criterion” -Boyles Asset Management, LLC (2014)
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