what is kelly criterion 
the kelly criterion is a mathematical formula relating to the long term growth of capital developed by john l kelly jr while working at at t s bell laboratories it is used to determine how much to invest in a given asset in order to maximize wealth growth over time understanding kelly criterionthe kelly criterion is currently used by gamblers and investors for risk and money management purposes to determine what percentage of their bankroll capital should be used in each bet trade to maximize long term growth after being published in 1956 the kelly criterion was picked up quickly by gamblers who were able to apply the formula to horse racing it was not until later that the formula was applied to investing more recently the strategy has seen a renaissance in response to claims that legendary investors warren buffett and bill gross use a variant of the kelly criterion the formula is used by investors who want to trade with the objective of growing capital and it assumes that the investor will reinvest profits and put them at risk for future trades the goal of the formula is to determine the optimal amount to put into any one trade there are two key components to the formula for the kelly criterion the result of the formula will tell investors what percentage of their total capital they should apply to each investment the term is often also called the kelly strategy kelly formula or kelly bet and the formula is as follows while the kelly criterion is useful for some investors it is important to consider the interests of diversification as well many investors would be wary about putting their savings into a single asset even if the formula suggests a high probability of success kelly criterion limitationsthe kelly criterion formula is not without its share of skeptics although the strategy s promise of outperforming all others in the long run looks compelling some economists have argued against it primarily because an individual s specific investing constraints may override the desire for optimal growth rate in reality an investor s constraints whether self imposed or not are a significant factor in decision making capability the conventional alternative includes expected utility theory which asserts that bets should be sized to maximize the expected utility of outcomes 