The Kelly Criterion is a formula that uses the probability theory to compute the maximum return for a bet. The three basic underlying components are the probability of winning, the bet size, and the chance of losing. Basically, the size of the wager should equal the fraction represented by the probability of winning divided by the odds of losing, to calculate a truer probability of winning the bet.
For example, the formula is: Kelly %= W – [(1 – W) /R], with W representing the winning bets, and R indicating the ratio of the average gain from the winning wagers. Let’s say a particular game incurs losses 40% of the time with losses of 1%. This game wins 60% of the time and gains 1.5%. If you use these figures for the Kelly Criterion formula explained above, you will get: Kelly %= .60 – [(1-.60)/(.015/.01)], with the Kelly percentage equaling 33.3%.
In this example, you should use only 33.3% of your total betting budget to place wagers and you will not run out of money.
In games of chance where there are only two results, the Kelly percentage formula is simplified to: Kelly % = what the wager pays out divided by what the wager pays “to one”.
What is the best way to use it?
The best way to use the Kelly Criterion is to make sure you always proportion your bets according to how much your total budget is. By placing wagers computed with the formula, and with average betting results and chance, you can maximize the growth of your starting deposit. If you bet using more than the Kelly percentage in your wagers, your betting budget will decrease sooner and you are more likely to go bankrupt before you see gains.
If using the computed Kelly percentage seems too high a risk for you to take while gambling, you can use a more conservative approach and wager less than the indicated amount. While you will not see the maximum benefits from your bet, you will lose less of your money on wagers and yet still see some growth to your bankroll.
And last but not least
When using the Kelly Criterion, keep in mind that you have to know some information about the outcome of certain games before you can apply the formula. Most bettors understand that there is a certain amount of advantage to each game, and that this favor occurs with gains and losses within the occurrences. If you can provide estimates of these advantages/variances, your chances of building on your starting budget using the Kelly Criterion are increased.
While you aren’t all mathematics geniuses, you can still use this formula to increase your chances of winning that big jackpot and walking away from your desk with more money than you sat down with!