A mathematical formula for optimal bet sizing: the fraction of capital to commit to an investment is (edge ÷ odds), where edge is the probability advantage and odds are the net payoff ratio.
Deeper Explanation
The Kelly Criterion, derived from information theory by John Kelly, determines the position size that maximises long-run wealth growth: f* = (bp − q) ÷ b, where b is the net odds, p is the probability of winning, and q = 1−p. Full Kelly is theoretically optimal but produces very large position sizes and extreme drawdowns in practice. Most professional investors use "Half Kelly" or "Quarter Kelly" to reduce drawdown volatility while capturing most of the growth benefit. The criterion requires accurate probability estimates — and overconfidence in those estimates leads to over-betting, which is dangerous. Its value is conceptual: it forces investors to think explicitly about probability and payoff before sizing any position.
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