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Wow! Thanks, Bob, for hitting that nail squarely on the head!
John
>At 08:19 AM 9/19/97 -0700, you wrote:
>>Oops! I shouldn't have implied anything mysterious. It just seems to me to
>>be an odd idea: that one constant fraction of capital should optimize
>>portfolio growth. I'd like to find the original thinking behind that so I
>>could examine it closely.
>>
>John -
>
>It comes out of a very simple model in gambling theory, whose simplicity
>makes it only remotely applicable to real life investing and trading. As
>you may know, the result goes back to a paper by Kelly on information theory
>and to a couple of theorems by Breiman showing that the strategy is
>"asymptotically optimal". The Kelly criterion was publicized in the early
>70's by Ed Thorp and evidently some people just took the idea and ran with
>it. But it is in fact optimal only in a very special situation, namely when
>the distribution of your profit is the same on every bet -- ie when you are
>making precisely the same bet over and over, and only that bet. In the real
>world, you will have different situations with different possible outcomes
>and differing probabilities associated with those outcomes. If the
>distribution changes from bet to bet, the assumptions behind these results
>will not pertain, and the fraction of your capital you should bet in order
>to achieve maximal capital growth will depend upon the particular
>distribution of profits that characterizes your current bet, and this
>optimal fraction will typically not be fixed at all but will vary from bet
>to bet.
>
>Bob P.
John Sweeney, Tech. Editor Technical Analysis of Stocks & Commodities
Technical Analysis, Inc. The Traders' Magazine
4757 California Ave. S.W. Phone: 206 938-0570 Fax: 206 938-1307
Seattle, WA 98116-4499 USA Web: http://www.traders.com/
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