What is the Kelly Criterion in Forex?
Quick Answer: The Kelly Criterion is a position-sizing formula that allocates capital based on edge and payoff ratio, guiding how much equity to risk per trade for maximum long-term growth when inputs are accurate.
Understanding the Kelly Criterion
The Kelly Criterion is a position-sizing formula that maximizes long-term growth by allocating capital based on edge and odds. For trading, the simplified version uses win rate and payoff ratio to calculate the optimal percentage of equity to risk per trade.
Applying Kelly in Forex
Kelly fraction = (bp - q) / b, where b is the reward-to-risk ratio, p is win probability, and q is 1 - p. If your system wins 55% of the time with a 1.8R average reward, Kelly recommends risking roughly 14% of equity—far too aggressive for most traders. Professionals typically use a fraction (e.g., 0.25 Kelly) to control volatility.
Fractional Kelly
Using quarter-Kelly keeps growth attractive while protecting against expectation errors. Combine the formula with conservative risk caps.
Practical Considerations
Kelly assumes independent bets and accurate probabilities, which few discretionary traders can guarantee. Use it as a guideline, not gospel. Stress test the output against worst-case drawdowns and layer on risk controls like position sizing limits.
Edge Uncertainty
Overestimating your edge leads to oversized Kelly bets and catastrophic losses. Update inputs with verified forward-testing data, not hope.
Related Terms
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