In this guide
Key takeaway: The Kelly Criterion calculates the optimal proportion of your bankroll to stake on any given wager, accounting for your probabilistic advantage and the available odds. In prediction markets, it solves two persistent problems: wagering excessively (risking total loss) and wagering insufficiently (forgoing potential gains).
The gap between a winning trader and financial ruin often comes down to bet sizing discipline. The Kelly Criterion — a mathematical framework created by John Kelly, a researcher at Bell Labs, in 1956 — determines the theoretically ideal stake amount for achieving maximum sustainable returns. This guide explains how to implement it within prediction markets.
The Kelly formula
For a binary prediction market (YES/NO), the Kelly fraction is:
f* = (p * b - q) / b
Where:
- f* = proportion of bankroll to stake
- p = your assessed likelihood of success
- q = likelihood of failure (1 - p)
- b = net odds (payout / stake). For a prediction market share trading at price c, b = (1 - c) / c
Worked example
Suppose you assess a 60% probability that an outcome resolves YES. The market is quoting 45 cents (suggesting 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
The Kelly formula recommends staking 27.2% of your capital. If your account holds $1,000, you would allocate $272 to this position.
Why full Kelly is dangerous
The Kelly formula presumes you can identify your true probability with certainty — an assumption that never holds in practice. Miscalculating your edge upward causes severe overexposure. Experienced traders almost always employ fractional Kelly:
- Half Kelly (f*/2): Industry standard among professionals. Yields roughly 75% of peak growth whilst cutting drawdown in half
- Quarter Kelly (f*/4): More cautious approach when edge estimates carry significant uncertainty
- Capped Kelly: Establish a hard ceiling—say 5-10% per market—irrespective of what Kelly suggests
Applying Kelly to multi-market portfolios
Holding stakes across several prediction markets at once requires scaling down individual Kelly allocations. The aggregate of all Kelly fractions must remain at or below 1.0 (your total capital). Practically speaking, cap combined exposure around 50% to preserve dry powder for emerging opportunities.
When Kelly does not apply
Kelly hinges on sound probability estimation. Several contexts undermine this assumption:
- Situations involving extreme ambiguity (unprecedented events lacking historical data)
- Dependent markets (such as presidential election outcome and legislative control, which move together)
- Markets where you lack any informational advantage relative to prevailing prices
Leverage PolyGram's integrated Kelly Criterion calculator to determine position sizes before executing any trade. The analytics suite also provides payoff visualisations and peak-to-trough loss reporting. Start trading on PolyGram →