The Kelly Criterion
Using calculus to optimize your bankroll
by Frank Cotolo
In this installment of our courageous-wagering series, we will begin to explain money management, as the bettor employs it.
A reminder: the explanations for this series go into great detail concerning its components, but when we are through defining all of the elements, you will be able to, as we promised in the beginning of this series, use the profit-playing plan in a simple form sans stressful, cumbersome work. That goes for playing with any amount for a stake (bankroll). That being re-established, let me take you through a brief history of the method used to campaign a pari-mutuel bankroll.
Henry Miller wrote that anything great that happens does so in the nature of contradiction. The story of John Kelly Jr., that brings us to a money-management method that has become a pillar for all forms of risk investments, is, indeed, the result of contradiction. Kelly was a Texan and graduate of the University of Texas who received his doctorate in 1953, after surviving a plane crash he piloted during World War II. He worked in the oil industry for a while, but quit when the laborious research he used to assist in finding oil was rejected because the company relied on a boss that preferred instincts to scientific data.
According to one biography of Kelly, drilling for oil was predicated on one person smelling the soil to decide drilling areas. Kelly was not impressed.
He took a job at Bell Labs in New Jersey, which was known as an important scientific research center. In contrast to his meticulous academic prowess, Kelly has been described as frenetic. He was a chain-smoking prankster with a penchant for guns and near-reckless behavior for the fun of it while being a husband and father of three children. Nowhere, however, was there any evidence of a connection between Kelly and gambling, no less pari-mutuel wagering.
Kelly was intrigued by a popular television quiz show, “The $64,000 Question,” which became the brunt of a federal investigation proving the program was fixed (all gamblers should see the
1994 docudrama “Quiz Show”). Kelly heard that people were making wagers on the show’s results and his mind centered upon the probable best return on such a wager.
At Bell Labs, Kelly worked closely with a man named Claude Shannon. He was an American mathematician credited as one of the founders of the digital age due to his “information theory.” Kelly recognized aspects of Shannon’s theory could be applied to pari-mutuel wagering, by maximizing the potency of a specific wager so as to offer a fair return and protect the stake. In other words, John Kelly Jr. created a formula that could be used to determine the optimal bet size to stretch one’s bankroll.
Later known as the Kelly Criterion, the formula presents the bettor with specific cash amounts to use based upon the subjective edge (odds) assigned to each contestant in a race field (as the handicapper evaluates). However, the amount can only be wagered when the public’s determination of the horses’ chances are represented on the toteboard by odds that offer more than the handicapper has established. This figure relates to what we explained in the June 2017 column about the true nature of “value” and that is represented in percentages, not raw dollar amounts.
There is no guarantee, however, that the safety gauges in the Kelly Criterion are preventions of total loss. The downside of using the method doesn’t weigh as heavily as the upside, but make no mistake about the difficulties in utilizing the method; they take courage, as you may have determined by now. The relation of the method’s success is in direct proportion to the accuracy a handicapper attains in establishing odds and the miscalculations of the public—which are numerous, for sure, allowing the handicapper to put extra trust in the sound mathematics of, particularly, pari-mutuel wagering.
Plus, using the method effectively means taking no diversions from its rules. Doing so is an overt battle of emotions. Many bettors cave when losing streaks ignite stress, which is unique in every person.
With courage, many others and I can testify the Kelly Criterion wagering scale is the best way to express profits from a wagering campaign. When this tool is used mechanically, it does more than provide our stake with healthy rewards by aiming at wagers of great value, it also dictates when we should not wager. That is, by and large, one of its endearing built-in attributes. Passing a wager because it does not meet the criterion is imperative and it, too, takes courage, especially in the throes of losses determined by stretched noses or inopportune disqualifications.
In the next issue, we will offer a working chart and directions for its use.