Kelly Criterion

By Lawrence G. McMillan

This article was originally published in The Option Strategist Newsletter Volume 17, No. 15 on August 15, 2008. 

Trading or investing involves several facets of operation: trade analysis, money management (including trade execution and position size), and follow-up action (including exiting the trade). Most successful and experienced traders agree that trade analysis is the least important – contrary to what a novice would expect. In fact, I have seen a successful system trader state that he could turn any reasonable system into a profit through proper money management (i.e., through proper position sizing and follow-up action).

If one is too conservative, he can ruin a successful system (by stopping himself out at the tiniest hint of a loss, for example). On the other hand, if one is too aggressive – say, leveraging position size up too aggressively when profits exist, he will also fail because one small downturn will eventually be a disastrous loss.

By Lawrence G. McMillan

This article was originally published in The Option Strategist Newsletter Volume 5, No. 3 on February 9, 1996. 

While speaking at two locations last week — Futures Magazine's "Futures South" and Option Vue's Seminar — it became apparent that traders and investors want guidance on money management. Not only do they want trade recommendations, but they want some guidance in the realm of how much to invest in a position, and how to properly place stops.

By Lawrence G. McMillan

This article was originally published in The Option Strategist Newsletter Volume 14, No. 10 on May 26, 2005. 

Statistically-based trading is normally applied to hedged positions. It could be pairs trades for stock traders, or option spreads for option traders, or intramarket spreads for futures traders. But generally, the position is one that is based on a relationship between the entities involved – whether that relationship be a price-based relationship or a volatilitybased relationship. The position can be evaluated using assumptions about price relationships or about volatility, and those assumptions are based in historic fact, upon which mathematical calculations can be made (expected return, for example, and then the Kelly Criterion).