The Kelly Criterion has been used by many successful sports bettors as a form of money management. Once a bettor’s bankroll has been established, the first step is determining the amount of each wager. The method favored by most sharp bettors involves wagering a percentage of one’s bankroll on every bet. This method is more commonly known as the Kelly Criterion, which we will dive into in the rest of this article.
History Of The Kelly Criterion
In 1956, the Kelly Criterion was developed by Edward L. Kelly, a physicist with AT&T’s Bell Laboratories. The Kelly Criterion was originally designed for betting on thoroughbreds but has since been applied to all kinds of gambling, including the stock market as well as blackjack.
Explanation Of The Kelly Criterion
The Kelly Criterion is a mathematical formula that provides the percentage of one’s bankroll that should be wagered on an event in order to maximize the potential profit, which is based on the odds and probability of winning the bet. The mathematical formula can be simplified in three steps:
1. Multiply the odds of the event by the probability of winning.
2. Subtract the probability of losing from the number calculated in step one.
3. From the number obtained from step two, divide it by the odds of the event.
Example Of The Kelly Criterion
As an example, let’s assume that we’re a football bettor with a 56% (.560) winning percentage over time and that we’re comfortable with using this percentage as our expected winning probability for future bets. Assuming -110 odds for the event that we’d like to wager on, here is how the three steps would be applied:
0.560 x (100/110) = 0.509
Since our odds of winning are .560, this means that our odds of losing are .440.
0.509 – 0.440 = 0.069
0.069 / (100/110) = 0.0759
From the example above and based on the Kelly Criterion, this tells us that we should be wagering 7.59% of our bankroll on this event in order to maximize our potential profit. While the Kelly Criterion may also be used when your odds of winning are less than 50%, since the odds are in your favor in this example, this means that in the long-run, such a situation, when it arises, should yield a profit.
Let’s move to the flipside where our odds of winning at less than 50% and provide an example. If we assume that we’re a baseball bettor and we’d like to take an underdog who we think has a 40% (.400) chance of winning at a +165 payout, here are the steps and corresponding calculations:
0.400 x (165/100) = 0.660
0.660 – (1 – 0.400) = 0.06
0.06 x (165/100) = 0.099
From the example above and based on the Kelly Criterion, this tells us that we should be wagering 9.90% of our bankroll on this event in order to maximize our potential profit. What this means is that although we believe that the underdog has a 40% chance of winning, the odds set forth by the oddsmakers indicate a probability of winning of lower than 40% – 37.74% to be exact. Because there is underlying value in betting on this event, the Kelly Criterion tells us that we should be risking a larger portion of our bankroll on this event due to the fact that in these types of situations, we’ll be profiting over the long-run.
Problems With The Kelly Criterion
While the Kelly Criterion seems like a foolproof method to ensure that you’re maximizing your potential profit on each event wagered on, there are two key issues with utilizing the Kelly Criterion. The first problem isn’t related to the Kelly Criterion but rather, the fact that most sports bettors tend to overestimate their expected winning percentage since this is, after all, an arbitrary guess in most instances. The second and biggest issue with the Kelly Criterion is the fact that it was originally devised for horse racing. Since the Kelly Criterion was formulated to handle only one wager at a time, with the bankroll being recalculated once the first wager has been settled, this presents a problem with other betting options unrelated to horse racing. Additionally, anybody using the Kelly Criterion could easily be wagering their entire bankroll on multiple events in a single day – one of the quickest methods of wiping out your entire bankroll.