[choubix]

Hello everyone,

I am currently reading about the Kelly formula on various website.
I now understand better that money management is a powerful tool to use when trading.

However something escapes me:
Assuming one has a trading system tat delivers a positive expectancy BUT there are fewer winning trades than losing trades, how to use the kelly formula??

e.g:

winning trades : 45%
losing trades : 55%

average win: 2,000
average loss: 1,000

expectancy is positive with : 0.45 * 2,000 - 0.55 * 1,000 = 350

Yet the K% would be negative because there are only 45% winning trades.

K% = (0.45 - 0.55) / 2 (where 2 is derived from 2,000 / 1,000)

Is there a more "refined/updated" Kelly formula that addresses this issue or this kind of bet should be considered a bad trade and should be avoided ?

Thanks!

[equtrader]

K% = Expectancy/average winner = 350/2000 = 0.175 or 17.5%

This is the best paper on Kelly I have been able to find:

http://www.priceactionlab.com/Literature/Kelly.pdf

Read the examples at the end.

[choubix]

Thank you for your post Equtrader.

I've printed the document and will read it in a short while!

Happy new year to you.

+++

[choubix]

actually I also made a mistake as I wrote : K% = (0.45 - 0.55) / 2 (where 2 is derived from 2,000 / 1,000)

when actually it should be:

K% = 0.45 - ( 0.55 / 2 )

which returns a positive result (17.5% as you mentioned equtrader)

Tks!

[equtrader]

Originally Posted by choubix »

actually I also made a mistake as I wrote : K% = (0.45 - 0.55) / 2 (where 2 is derived from 2,000 / 1,000)

when actually it should be:

K% = 0.45 - ( 0.55 / 2 )

which returns a positive result (17.5% as you mentioned equtrader)

Tks!

ur welcome with a delay

[silentdud]

Originally Posted by choubix »

Hello everyone,

I am currently reading about the Kelly formula on various website.
I now understand better that money management is a powerful tool to use when trading.

However something escapes me:
Assuming one has a trading system tat delivers a positive expectancy BUT there are fewer winning trades than losing trades, how to use the kelly formula??

e.g:

winning trades : 45%
losing trades : 55%

average win: 2,000
average loss: 1,000

expectancy is positive with : 0.45 * 2,000 - 0.55 * 1,000 = 350

Yet the K% would be negative because there are only 45% winning trades.

K% = (0.45 - 0.55) / 2 (where 2 is derived from 2,000 / 1,000)

Is there a more "refined/updated" Kelly formula that addresses this issue or this kind of bet should be considered a bad trade and should be avoided ?

Thanks!

The Kelly formula is only useful if you are taking on a single trade at once. You will not make money if you play a single trade of the same strategy at one time unless you are highly leveraged or you have a substantial cash reserve. Also you will take larger hits to your cash reserve. It's a good lesson for making basic trades, but it is really poor in terms of actual risk management. I know for a fact that Edward Thorpe used to use it, but he was old school and there have been so many innovations since then.

For example, if you play 5 games of poker that are within your bankroll instead of one you are diversifying away some of the risk. On the other hand, when you try to do this with stocks there is a correlation of every single security to every single other security and you need to acknowledge this other wise you will loose a lot of money.

It's also important to pay attention to skewness in return distributions (not accounted for in the kelly criteria) and Kurtosis (which Long Term Capital Management ignored and caused them to be ruined).

Here are two popular books on portfolio management:

Managing Investment Portfolios: A Dynamic Process (CFA Institute Investment Series)

The CFA institute publications are usually very good but this book includes extra types of portfolio management which you might not need.

You may want to look at this one which is cheaper and its highly rated:
The Intelligent Asset Allocator: How to Build Your Portfolio to Maximize Returns and Minimize Risk


You should realize that a lot of the theory that is in these can actually be applied to modern portfolio theory. I also highly recommend that you look at some of Edward Thorp's papers, although they are highly outdated.

[http://edwardothorp.com/id10.html]Edward Thorps publications[/url]


Hopefully that helps!

-Silentdud

[SunnyJHarris]

I have a modified Ralph Vince optimal-f that I call Ultimate-F, because it avoids the high risk of ruin. It is much better than the Kelly formula and still compounds your results dramatically. YES, it works great with 45% or even 40% as long as your CPC Index is greater than 1.2.

Originally Posted by choubix »

Hello everyone,

I am currently reading about the Kelly formula on various website.
I now understand better that money management is a powerful tool to use when trading.

However something escapes me:
Assuming one has a trading system tat delivers a positive expectancy BUT there are fewer winning trades than losing trades, how to use the kelly formula??

e.g:

winning trades : 45%
losing trades : 55%

average win: 2,000
average loss: 1,000

expectancy is positive with : 0.45 * 2,000 - 0.55 * 1,000 = 350

Yet the K% would be negative because there are only 45% winning trades.

K% = (0.45 - 0.55) / 2 (where 2 is derived from 2,000 / 1,000)

Is there a more "refined/updated" Kelly formula that addresses this issue or this kind of bet should be considered a bad trade and should be avoided ?

Thanks!

[silentdud]

I can see a few problems with optimal-f from just a quick look at it though. It is guilty of the same problem that problem that the Kelly criterion is, i.e. not looking at the instances around the mean, only at the estimated values. Does the modified version fix this?? Do you have any links describing its calculation?

As far as I can tell it is only useful for ball parking and quick, on the spot math.

I looked at this for information on calculating the original "optimal" f.
Contango: Optimal f

Thank you.
Silentdud