Fortune's Formula - Book Review from SIAM News Magazine
JE Kelly original Paper "A New Interpretation of Information Rate"
Kelly followers: Buffett, Munger, Legg Mason Capital Management CEO Bill Miller, per Peter Lindmark 2007 article at gurufocus.com; Bill Gross as per Wikipedia article stating that "taking more risk increases the probability of both very good and very bad outcomes. One of the most important ideas in Kelly is that betting more than the Kelly amount decreases the probability of very good results, while still increasing the probability of very bad results. Since in reality we seldom know the precise probabilities and payoffs, and since overbetting is worse than underbetting, it makes sense to err on the side of caution and bet less than the Kelly amount".
As one blogger simply put it:
"The formula is 2p - 1 = x
Where p is the probability of success, x is the portion of your bankroll (or portfolio) that should be allocated to this bet. If an event has a 40% chance of paying off, don't bet. If a bet has a 55% chance of winning, only put in 10% of your money. If the chance of winning is 95%, invest 90% of your money.
A Kelly bet is the most aggressive bet you should ever take. Bets larger than Kelly are inefficient money management and will cause you to lose your money. The Kelly bet size does not ensure the highest probability of making a gain, it ensures the highest profitability for a set of games, or trades. It is also known as "tear your hair out" trading, as in practice they are actually quite big bets for many games and your equity curve will be extremely volatile.
P.S. Peter Lindmark's return:
Lindmark Capital 2008 Peter Lindmark's Contrarian Book Recommendations
In an exclusive interview with Downside Protection Report, Peter Lindmark recommended the following books, which he has read or re-read recently:
- Changing Fortunes by Paul Volcker and Toyoo Gyohten
- Speculative Contagion by Frank Martin
- A Demon of Our Own Design by Richard Bookstaber
- The Power of Gold: The History of an Obsession by Peter Bernstein
- Simple But Not Easy by Richard Oldfield
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