How the Kelly criterion works
The Kelly criterion is a formula that calculates the optimal fraction of capital to risk on a bet, given its edge and odds. It maximises long-run growth while mathematically avoiding ruin, by sizing each position in proportion to how much of an advantage you actually have. The bigger and more reliable your edge, the more Kelly says to bet; with no edge, it says bet nothing.
Worked example
Suppose a strategy wins 55% of the time at 1:1 odds. Kelly suggests risking about 10% of capital per trade (the edge, 10%, divided by the odds). That is aggressive: a string of losses would still cut deep, which is why most professionals use a fraction of Kelly, often a quarter or half, to soften the drawdowns while keeping most of the growth.
Why full Kelly is too aggressive
Full Kelly assumes you know your true win rate and odds exactly, which in real markets you never do, so it routinely overbets and produces brutal drawdowns. On Volity, the practical takeaway is the principle, not the raw number: size up when your edge is strong, size down when it is weak, and never bet so much that a normal losing streak threatens the account. Fractional Kelly is the usual compromise.
Why it matters
Kelly is the rigorous answer to the most important question in trading, how much to risk, and it proves that both overbetting and underbetting cost you long-run growth. Use it as a ceiling and a discipline, not a literal instruction. Related: position sizing and risk-reward ratio.
Learn more in our learn trading hub.
