In this guide
Key takeaway: The Kelly Criterion determines the optimal percentage of your bankroll to deploy on each trade, accounting for your edge and the available odds. In prediction markets, it solves two critical problems: wagering excessively (and facing bankruptcy) or wagering conservatively (and forgoing gains).
Bet sizing separates winners from losers in trading. The Kelly Criterion — a mathematical framework invented by John Kelly, a researcher at Bell Labs, in 1956 — calculates the theoretically optimal stake for achieving maximum compounded returns over time. This guide shows how to implement it in prediction markets.
The Kelly formula
For a two-outcome prediction market (YES/NO), the Kelly fraction is:
f* = (p * b - q) / b
Where:
- f* = percentage of bankroll to stake
- 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 resolves YES. The current market quotation stands at 45 cents (reflecting a 45% implied 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 formula recommends committing 27.2% of your capital. If your account holds $1,000, you should allocate $272 to this position.
Why full Kelly is dangerous
The Kelly formula presumes you possess perfect knowledge of your true probability — a condition that never materialises in practice. Misjudging your edge upwards triggers severe overexposure. Experienced market participants rely on fractional Kelly instead:
- Half Kelly (f*/2): The industry standard. Surrenders roughly 25% of theoretical gains but cuts volatility in half
- Quarter Kelly (f*/4): A more cautious approach when your edge assessment carries substantial uncertainty
- Capped Kelly: Establish a hard ceiling — perhaps 5-10% of total capital per market — regardless of what Kelly prescribes
Applying Kelly to multi-market portfolios
Once you hold stakes across several prediction markets concurrently, individual Kelly percentages require recalibration. The aggregate of all Kelly allocations should remain at or below 1.0 (your full bankroll). Practically speaking, limit cumulative exposure to 50% so you retain dry powder for emerging opportunities.
When Kelly does not apply
The Kelly formula hinges on reliable probability estimation. Several scenarios undermine this assumption:
- Unprecedented events lacking comparable historical data
- Linked outcomes (such as a presidential race and Senate control, which move together)
- Markets where your insight matches the crowd consensus rather than exceeding it
Leverage PolyGram's integrated Kelly Criterion calculator to determine position sizes ahead of each trade. The analytics suite encompasses scenario payoff charts and maximum drawdown metrics. Start trading on PolyGram →