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What is the Kelly Criterion?

What are the problems with the Kelly Criterion?

By by Miles Michelson

There are a number of problems with the system, but none that are critical or make it impossible to use. The Kelly Criterion works best when you know the final odds of all the horses involved. Since this isn't practical in pari-mutuel betting, you'll have to make do with odds taken a few minutes prior to post. It also assumes that you can judge each horse's chance of winning better than the crowd at large can (in other words, that you can accuratly spot overlays and underlays). To make money with the Kelly Criterion this is essential because the amount you are supposed to bet depends for the most part on the difference between a horse's actual odds and the fair odds as you perceive them.

The Kelly Criterion is also meant to be a long-term money management system. Rather than going to the track each weekend with $100 in your pocket and betting it all, it's assumed that you are keeping track of your overall bankroll for a long period of time, not replenishing it with new money each time you head out to the track. For most handicappers this is a complete change in the way you deal with your money and it'll require you to set aside a bankroll which you'll need to stick with for a while. Using the Kelly Criterion any other way is pointless because it defeats the purpose of Kelly's system which is long term bankroll growth.

The Kelly Criterion also becomes less practical to use when your backroll gets smaller. In his original paper, John Kelly assumed that you could always bet a percentage of your bankroll, even when that percentage amounted to less than a dollar. Mathematically this works great, bet 50 cents of the one dollar remaining in your bankroll, if you lose, bet 25 cents, etc. However, at a track that only allows $2 minimum bets you'll quickly realize how silly this is. So if your bankroll goes down to a few dollars, it's probably a good time to make a mental note that your ability to spot overlays isn't as good as you thought it was and start over from scratch.

It's also very possible that the Kelly Criterion will advise you to make a wager (albeit a small one) on a horse with negative expected rate of return. In other words, a horse may be at odds of 40-1 on the board and you might perceive its fair odds to be 35-1, but you'll be told to bet a small amount on the horse anyway. That's just the way the math works and it's the exception, not the rule.

The Kelly Criterion also requires some preparation before heading to the track and a lot of math. Many handicappers aren't used to creating their own morning line before heading out to the track, but if you want to use Kelly's method, it's a must. Some simplifications of the system allow you to simply figure out how much to bet based on the odds of a horse and the odds you feel it should be at, but I wouldn't reccommend using those variations unless you're too lazy to build your own morning line.

For most people, it's simply too much math to do in one's head or to use a calculator at the track as a result, many handicapping books have boiled Kelly's method down to simple statements such as:

Bet more money as your bankroll grows and less when it shrinks.

or...

Bet a certain percentage of your bankroll.

or..

Bet more on a horse when you perceive it to be an overlay and less when it's an underlay.

While all true, these statements may do more harm than good because if put into use without underlying math, they do no more than make you feel like you're using good judgement. The actual Kelly Criterion allows you to quantify exactly how much you should bet on a given horse based upon its odds and what you consider to be fair odds. The above statements do no more than summarize some of the aspects of the Kelly Criterion.

While there are some mathematical simplifications of the Kelly Criterion that make it easier to use, they are also approximations and don't always suggest the proper amount to wager on each horse. To be used at the track, you'll need a computer program or programmable calculator to do all the number crunching for you.

Part 3 - Scaling Back on the Optimal Kelly Wager plus links to further reading
Part 1 - What is the Kelly Criterion?

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