Position Sizing And Kelly Criterion
How long you stay in the game depends less on what you take when you win, and more on what you leave on the table when you lose.
The fastest way to go bankrupt in the market is committing the entire treasury to a single probability, trusting the high likelihood of being right. Position Sizing is the life-or-death mathematics determining exactly what percentage of the treasury will be risked in each trade. Setting stop-loss levels alone is insufficient; the core issue is pre-calculating a volume that ensures when a stop triggers, the treasury loses no more than 1% of its total.
The sharpest formula for this discipline is the Kelly Criterion. The Kelly formula examines an investor's win probability and risk/reward ratio to output the optimum trade volume that will grow the treasury fastest over the long run. It increases volume if the probability is high, and shrinks it if low. However, utilizing the full Kelly fraction is often psychologically exhausting; thus, professionals employ "Half Kelly," sacrificing theoretical maximum speed but entirely eliminating the Risk of Ruin during a streak of bad luck.
