BASIC OF KELLY STANDARD

There are two basic elements that make up the Kelly Standard:
  • Win rate (W): the probability of you winning the total trade.
  • Reward: Risk (R): profit/loss pips.
We have the following formula:

Kelly% = W - [(1 - W) / R]

HOW TO USE KELLY STANDARD

The Kelly system can be used according to the following steps:

1. First, you must have a history of the size of 50-60 commands. You review your history and then statistic again or have to backtest the system if you do not have history.

2. Calculate the number "W". For example, if you trade 50 orders, you win 20 orders then W = 20/50 = 0.4. This number is as close to 1 as possible, usually above 0.5 is ok.

3. Calculate the number "R". Reward: Risk Ratio, everyone knows. This number is greater than 1 then ok, that means your profit is enough to compensate or exceed the risk that you incur.

4. Substitute the number into the formula, calculate K%.

EXPLAINING KELLY STANDARD RESULTS

The K% rate (always less than 1) will indicate the optimal volume to trade for. For example, if K% = 0.05, you should only spend 5% of your account to risk each trade. This system basically tells you how you should balance your portfolio.

But a rule to remember is that no matter what K% gives you, it should not exceed 20-25% of the account for 1 trade. If so, it could be risky for you.

There is no perfect Capital Management system. This system will help you to diversify your portfolio effectively through the appropriate allocation of capital for each trade order, each currency pair, or each stock for the most optimal way. But there are many things it cannot do. It cannot choose which currency pair is right for you to trade or herald a sudden market decline. (But it can reduce your risk.)

Above is an introduction to Kelly standards. According to this standard requires you to have a trading system and have to test it with a large enough order to statistic:
  • Win rate
  • Reward / Risk ratio
Then apply the above formula to find the solid trading volume in the long run.