Kelly Criterion in detail | Hacker News Reader

Kelly Criterion in detail

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61 pointsdedalus8 comments

I have a feeling this could be one of those stories on HN where it gets a bunch of upvotes but not very much discussion.

If you enjoy pop economics/trading books ala Michael Lewis then I'd recommend Fortunes Formula. Great book focusing mostly on Ed Thorpe who is one of the fathers of modern day quantitative trading.

https://www.amazon.ca/Fortunes-Formula-Scientific-Betting-Ca...

I don't want to speak for an industry, but I don't see it used very much in practice in investing anymore, mostly because firms nowadays seem to make much smaller bets much more frequently( think HFT firms) so even pension funds that don't do investments under say $20-$30 million are usually doing sizes that amount to 1/50 of Kelly.

It may have use for very small individual investors, think someone with under $100,000 to invest that wants to pick their own holdings and not jut buy the market via an ETF.

Having said that, if you want to work on the buy side soon er or later someone will ask you about it during an interview so its in your best interest to understand it.

Kelly has almost no use for your random small investor. Kelly is all about when you have a very good idea of your edge over the market (first assumption is that you have an edge, very few do).

If you're a bedroom trader, it's unlikely you have enough data and a big enough trading history to accurately gauge your market edge. You might well be up 30% in the last year, but that does not mean you've got a 30% edge.

When you do have a good estimate of edge, then kelly can come into play. But even then, the theoretical basis of kelly is that money in infinitely indivisible and you can trade at tiny fractions of your total bankroll. So, you normally need to bet less than the kelly stake, but how much less? It's a black art in markets where edges vary with time, along with your skill, perceived skill and measurable skill.

I second the recommendation. I expected it to be mediocre at best, but _Fortune's Formula_ is actually both good on the the technical & philosophical aspects of Kelly, and on the history & people involved.

William Poundstone is one of my Guilty Pleasures. I've been reading (and re-reading...) his books for years, starting with his Big Secrets series, and he is always interesting and thought-provoking, while not taking himself too seriously. Think a better Malcolm Gladwell, but with a worse PR team.

Also, if you know a little bit about finance and are interested in Ed Thorp, read his papers. For example,

https://books.google.de/books?id=uOPa9XtzoJ4C&lpg=PA181&ots=...

should give you a feeling of how his hedge fund was working.

One thing most people don't think about. The kelly criterion isn't particularly useful for investors, as you need to be able to quantify the expected outcomes. It's not particularly useful for gamblers (rarely do they have quantifiable positive expected value), but it's an absolutely amazing resource for casinos themselves.

Almost every bet that happens on a casino floor the casino can quantify their expected returns and risks and knowing the state of their bankroll knowing what is sensible to risk or not.

But other than that, it probably is mainly useful to teach investors a healthy fear of variance. If it'd be foolish for a casino with a $1M bankroll to let a roulette player bet more than $12000 on a spin, it might give you a healthy sense of the importance of diversification.

Every pro gambler and every syndicate I know is trading based on a model, so I'm not sure Kelly's quite as rare in gambling as you think. I do think it's interesting to think about the work required when adding expert judgements on top of model outputs, though.

Anyone want to give example inputs for the calculator? I find it very confusing. Are the Odds input as percentages? Decimal Odds?

I created http://sportsbettingcalcs.com/#kelly_calculator which I have pre-filled with an example which is much more intuitive to me. This calculator is more advanced, as it can maximize over multiple bets, but I'm finding it difficult to use. Another calculator which I have no affiliation with is http://www.sportsbookreview.com/picks/tools/kelly-calculator...

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