Kelly criterion is a mathematical formula rooted in probability theory. Developed by John Larry Kelly Jr. in the year 1956, this formula is used to determine the bet size in a given asset and boost profits over time. Since its introduction into gambling, it has become quite popular among the investing community. Claims are that great investors like Warren Buffet and Bill Gross use this formula to make bets and increase their profit potential. In this article, let us see what the Kelly criterion is and how it helps manage investments and reduce risk.
Understanding Kelly Criterion and Its Significance in Gambling
Kelly criterion, also known as the Kelly strategy or Kelly bet, is a formula designed to size bets and maximize the long-term growth of the investments you make. This method is mainly used in gambling. In simple words, it allows investors to find the exact amount of money that they have to place in a bet based on the predefined percentage of the capital invested.
As the capital you invest is also a factor in deciding the returns you make, it is important to have clarity about how much you should devote to each bet. The Kelly criterion helps with this thereby reducing risks and increasing profits. In the following section, let us look at the Kelly criterion gambling formula used to calculate the bet size.
Kelly Bet Gambling Formula
The Kelly Bet criterion focuses on the fraction of your funds (current bankroll) to bet on a result whose odds are higher than expected. This is how it helps maximize your profit potential over a longer period. The formula is as follows:
f = (bp – q) / b
where,
- ‘f’ is the proportion of the bankroll devoted to a bet
- ‘b’ is the decimal odds – 1 of the wager
- ‘p’ is the winning probability of the bet
- ‘q’ is the losing probability of the bet
Kelly Criterion Betting Example
Here is an example that will help you understand the Kelly criterion formula better.
Whatever the event be, consider the chances of winning the bet to be 60% (p = 0.6, q = 0.4) and the player gets 1-to-1 odds on a winning wager (b = 1). Let’s calculate the fraction of the bankroll required to bet.
f = (bp – q) / b
= (1*0.6 – 0.4) /1
= 0.2
So, f = 0.2
This means that you have to wager 20% of your bankroll each time to minimize risks and increase your profits.
Kelly Betting in Different Events
The use of Kelly betting in various events like sports betting, casino games, etc. differs. Here, we will go through some of the gambling events and see if this formula can be applied to them.
- Sports Betting- As sports betting is dynamic, Kelly betting won’t be that easy. You have to opt for the handicap method in this strategy to continuously assess the odds.
- Casino Games- The Kelly method does not work well for casino games due to the house edge factor. So, the house always has an advantage and the return to player (RTP) rate will never be 100%. This implies that the application of the Kelly criterion will yield a negative betting percentage.
- Basketball Betting- Kelly criterion can be successfully used in basketball games due to their dynamic odds and frequent scoring.
Pros and Cons of Kelly Criterion
In this section, let us weigh the positives and negatives of the Kelly criterion.
| Pros | Cons |
This method reduces the risks It provides a betting strategy Can maximize your profits Used by successful investors | If the probabilities are not accurate, you will not get the exact percentage of your bankroll to invest in a bet In some cases, a huge percentage of your bankroll will be needed Might not be suitable for beginners |
Conclusion
Kelly Criterion, the mathematical formula for calculating bet sizes and thereby long-term growth is used in gambling. This helps get clarity about the amount to wager so that you can reduce risks and increase profits. In this article, we have looked at the unique formula followed and also if the method applies to different gambling events like sports betting, casino games, etc. It is evident that the Kelly criterion is apt for some events like sports betting while not for others like casino games. So, the method has both positives and negatives.
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