If you’re looking to take on investing on your own, there are some important tools and strategies you’ll need to know. Many of these are simple equations you can adapt to a number of markets. One such is example is known as the Kelly Criterion.
This simple equation was invented by John Larry Kelly Jr. He came up with during his time at AT&T Laboratories and it’s used to relate capital’s long term growth.
Though it’s great for conventional investing, many gamblers also use it as a way of deciding how much of their assets to put on the line. The equation states:
W – [(1 – W)/R]
In the equation, W stands for the probability this investment will come back with a positive return. The R is your win/loss ratio or the amount of positive trades divided by the total negative trades.
When the equation is plugged in with real numbers, Kelly’s theory is that you’ll know what percentage of your capital you should put toward any given investment. Again, many gamblers use this to decide how much of their bank roll they should risk at any given time.
Kelly published this equation back in 1956 and since then it’s become the gold standard for many people when it comes to risking money. Originally, it was actually used by horse gamblers to help with their bets. However, over time, investors picked up on its potency.
Though it was originally commonplace amongst lowly horse gamblers, the fact that Wall Street picked up on it to see major gains goes a long way in verifying this equation.
