I read this in a book and just pasting it here as it is
can be of use for efficient use of capital
very useful
""" I was using something called the Kelly formula that Ralph Vince
had popularized. I found the Kelly formula in a little blackjack
book, and Ralph and I started fooling around with it and it led to
the whole thing of money management. Actually J.L. Kelly Jr. originally
devised the formula for the flow of electrons through circuitry.
But he said you could apply it to blackjack betting to measure risk/
rewards, too, and then we applied it to trading. It’s very wild and it
will exponentially increase the number of contracts you’re trading
when you’re winning, so you see that we stepped up from 1 lot to 30
lots rapidly. But when you lose money you’ve got to step back down.
I use a variation of that in my own trading today.
Can you explain the specific formula?
Let’s put F as amount of capital to trade. The amount of capital
equals the payoff ratio — that’s the risk/reward ratio — plus 1,
divided by probability — the system accuracy — minus 1.
So F = (payoff ratio + 1) / (probability - 1)
I did some tables on it. Let’s say your system is 40% correct and has
a 2.5 risk/reward ratio, you’ll use 16% of your money. If your system
is 63% correct with a 2.5 risk reward/ratio, you’ll use 55% of your
money on every trade. So it varies by accuracy. It’s a matrix of the
accuracy versus a risk/reward ratio.
can we have a small afl for this