Kelly criterion

[SanMiguel]

I was discussing this with a trader today and wondering on some other people's thoughts.
http://www.investopedia.com/articles/trading/04/091504.asp

Supposedly with a win ratio of 60:40 and a RR of 1:1, we should make each trade with 20% risk (could reduce to 10% to allow for errors).

It seems common knowledge that traders use around 2%. Why the discrepancy between that and what the Kelly criterion says is the best risk amount?

 

[Martinghoul]

There's all sorts of issues with Kelly... There's a lot written about it.

 

[SanMiguel]

There's all sorts of issues with Kelly... There's a lot written about it.

Seems to be common for stock investors but maybe that's just because of when it was published. You can put 10% capital into an equity but the risk of the stock going to zero is very small. However, it was originally designed for horse racing.

some optimisations include: http://www.brainyforex.com/position-sizing-methods.html
Most people in trading seem to used fixed sum trades.

 

[SanMiguel]

Any other thoughts?
the standard 2-5% risk for trading must come from somewhere...either that or it is one of the trading folklaw things...

 

[fayalac]

SanMiguel already told you, it was originally made for other porpouses, not preciselly horse races, but in fact not for the markets.
Why the percentage differ?, well that is a matter of money management.
I can put in risk an amount which in case of a sudden reversal will not cause me a loss that can risk or erase my account, many use 2%, others claim 0.5% and the most agressive say 5% is a good parameter, the main problem is not the percentage but the criteria you will follow to close a losing position. It depends on your system and your risk/money management criteria.

 

[trader3cnd]

Any other thoughts?
the standard 2-5% risk for trading must come from somewhere...either that or it is one of the trading folklaw things...

Here is a paper you should read from a real guru, not authors who never traded:

http://www.tradingpatterns.com/Literature/Kelly.pdf

This paper will answer most of your questions. It answered all mine.

P.S. Here is another one from the same author:

http://www.tradingpatterns.com/Literature/PositionSizing.pdf

Read that too, it is a good piece.