What is the Kelly Criterion formula?

The Kelly Criterion formula is: f* = (bp - q) / b, where f* is the fraction of bankroll to bet, b is the odds received, p is the probability of winning, and q is the probability of losing (1-p). It calculates the mathematically optimal bet size to maximize long-term growth.

Why do hedge funds use the Kelly Criterion?

Hedge funds use the Kelly Criterion because it maximizes the geometric growth rate of capital over time. It balances the tradeoff between betting too little (leaving money on the table) and betting too much (risking ruin). Firms like Renaissance Technologies are known for applying Kelly-style position sizing.

What happens if I bet more than Kelly optimal?

Overbetting (betting more than Kelly optimal) increases volatility and reduces long-term expected growth. Extreme overbetting can lead to ruin even with a positive edge. Risk Lab penalizes overbetting harshly in its scoring to teach proper position sizing discipline.

How is Kelly efficiency calculated in Risk Lab?

Kelly efficiency measures how close your bet sizes are to the theoretically optimal Kelly fraction. 100% efficiency means perfect Kelly betting. Scores above 100% indicate overbetting, which is penalized. The game tracks your efficiency across all rounds to assess your risk management skill.

Should I use full Kelly or fractional Kelly in real trading?

Most professional traders use fractional Kelly (typically 1/4 to 1/2 Kelly) in real trading. This accounts for estimation errors in edge calculation and provides a smoother equity curve. Risk Lab teaches full Kelly concepts, which you can then apply fractionally in practice.