The practical application of the Kelly criterion in the crypto world trading

Many traders are asking: how to scientifically determine the position size for each trade? The answer may lie in an ancient mathematical tool - Kelly Criterion.

What is the Kelly Criterion?

The Kelly criterion was proposed by scientist Kelly at Bell Labs in 1956, and the core idea is super simple: calculate the optimal position size ratio based on your win rate and odds. The formula looks like this:

f = (bp - q) / b*

Among them:

• f* = The proportion of funds that should be invested
• p = Winning Probability
• q = failure probability (1-p)
• b = Profit and Loss Ratio (profit/loss)

Practical Examples

Assuming you are optimistic about a certain cryptocurrency, with a win rate assessment of 60% and a risk-reward ratio of 2:1 (earning 200 yuan and only losing 100 yuan), substitute into the formula:

f* = (2×0.6 - 0.4) / 2 = 0.4

This means that a single investment should account for 40% of the total capital. This way, you can seize opportunities without directly risking a total loss due to a single failure.

Advantages vs Pitfalls

Advantages:

• Help you avoid excessive leverage or being overly conservative
• Maximizing long-term compound growth
• More disciplined trading

Pitfalls:

• The fluctuations in the crypto market are too intense, and the probability estimates are inherently inaccurate.
• Black Swan events (policy, technical risks) Kelly cannot calculate
• If you misestimate the probability, a single loss could peel away a big layer of skin.
• Did not consider the real costs such as trading fees, slippage, and psychological pressure.

How to use it reliably?

1. Do not mechanically apply: Kelly's 40% is not a ceiling; you can take a discount, for example, use 20%-30% to reduce risk.
2. Continuous Adjustment: The market changes quickly, so you need to regularly update your win rate assessment and profit-loss ratio.
3. Combination Thinking: Don't just look at Kelly, but also consider position diversification and spot hedging.
4. Psychological Factors: Large losses have a significant impact on mentality, and one must be able to accept them.

In simple terms, the Kelly criterion is a reference, not an absolute truth. Money in the crypto world is hard to earn, and no matter how clever the mathematical model is, it cannot change the madness of the market itself. It can be used to optimize thinking, but do not be superstitious.