How to use the Kelly Criterion when betting
How can you benefit from using the Kelly Criterion?
If you are gambling for profit rather than for entertainment, you should always focus on the numbers instead of following your emotions. Mathematical formulas for staking such as the Kelly criterion often prove to be very helpful as they provide a logical framework for determining the amount of money to be placed on each bet.
Before placing bets it is usually useful to consider the questions: Who, What, When, Where, Why and How much? In this article we are going to be dealing with the last one, which is how much. How much money should we be placing on a bet once we have decided that we are going to put money on.
A popular staking method where your stake amount is proportional to the edge you think that there is.
So to analyse the steps of placing a bet in the English Premier League. It would go something like this:
Who will we bet on? Chelsea
What are we betting on? For them to win
When are we placing the bet? Now
Where are we betting? At X bookmaker who have the best odds
Why do we bet? We think Chelsea have a better chance of winning than the odds suggest
How much should we stake? HERE is where people often go wrong, and the Kelly Criterion can help
Most articles that you will read deal with the first five questions but the 6th is so important. If you think of betting as you do with other financial products, how to divide your capital is crucial to manage your portfolio effectively. It is the same when you place a bet.
Many articles suggest using the Kelly criterion or some variant of it when it comes to staking methods. Basically, with the Kelly criterion we calculate what percentage of our capital we should wager on each value bet, because using this will see our capital growing exponentially.
The Kelly Criterion formula is:
(BP - Q) / B
B = The decimal odds available -1
P = The true probability of winning
Q = The true probability of loosing (1-P)
A coin toss example to help understanding of the Kelly criterion
For example, suppose you bet on heads at 2.00. However, let’s say that the coin is biased and has a 52% chance for heads.
In this case:
P = 0.52
Q = 1-0.52 = 0.48
B = 2-1 = 1
This results in: (0.52 x 1 - 0.48) / 1 = 0.04
Therefore, the Kelly criterion would recommend that we bet 4% of our capital on this bet. Any positive percentage indicates an advantage in favour of our capital, therefore our capital will increase exponentially.
The Kelly criterion offers a clear advantage over many other staking methods, as it involves less risk, reducing your bet stake as your bankroll declines eliminating the risk of ruin. However, it is hard to implement as it requires skill to accurately predict the probability of an outcome occouring.