In this guide
Key takeaway: The Kelly Criterion determines what percentage of your capital to allocate to each bet, accounting for your edge and available odds. Within prediction markets, it solves two persistent problems: wagering excessively (exposing yourself to bankruptcy) and wagering insufficiently (forgoing potential gains).
Bankroll allocation separates consistently profitable traders from those facing financial ruin. The Kelly Criterion — a mathematical framework created by John Kelly, a researcher at Bell Labs, in 1956 — delivers the theoretically ideal stake magnitude for achieving maximum compound returns over time. Below is guidance for implementing it across prediction markets.
The Kelly formula
For a two-sided prediction market (YES/NO), the Kelly fraction is:
f* = (p * b - q) / b
Where:
- f* = portion of capital to wager
- p = your assessed likelihood of success
- q = likelihood of failure (1 - p)
- b = net odds (return / investment). For a prediction market share trading at price c, b = (1 - c) / c
Worked example
Suppose you assess a 60% probability that an outcome settles YES. The current market quotation stands at 45 cents (reflecting an implied 45% probability).
- p = 0.60, q = 0.40
- b = (1 - 0.45) / 0.45 = 1.222
- f* = (0.60 * 1.222 - 0.40) / 1.222 = (0.733 - 0.40) / 1.222 = 0.272
According to Kelly, allocate 27.2% of your capital. If your total capital is $1,000, this corresponds to a $272 position in this opportunity.
Why full Kelly is dangerous
The Kelly formula presumes you possess perfect knowledge of your genuine edge — a condition that never materialises in practice. Misjudging your advantage upward results in severe overexposure. Experienced market participants almost universally adopt fractional Kelly:
- Half Kelly (f*/2): The predominant choice among professionals. Surrenders roughly 25% of theoretical gains but cuts volatility in half
- Quarter Kelly (f*/4): A prudent strategy when confidence in edge calculations remains limited
- Capped Kelly: Establish an upper limit of 5-10% of total capital per individual market, overriding Kelly's recommendation if necessary
Applying Kelly to multi-market portfolios
When you maintain concurrent stakes across numerous prediction markets, individual Kelly percentages require modification. The aggregate of all Kelly percentages must remain at or below 1.0 (your entire bankroll). Practically speaking, restrict cumulative capital deployment to 50% or less, preserving liquidity for emerging opportunities.
When Kelly does not apply
Kelly's validity hinges on your capacity to reliably quantify your genuine edge. Several circumstances undermine this assumption:
- Outcomes characterised by extreme ambiguity (unprecedented circumstances with minimal comparative data)
- Interdependent markets (presidential election results and legislative composition are statistically linked)
- Markets where your forecast carries no advantage relative to prevailing market sentiment
PolyGram offers an integrated Kelly Criterion calculator for determining position magnitude before each transaction. The analytical suite incorporates payoff visualisations and maximum drawdown metrics. Start trading on PolyGram →