In this guide
Key takeaway: The Kelly Criterion determines the optimal percentage of your capital to deploy on each trade, accounting for your perceived advantage and available odds. For prediction market participants, it solves two critical problems: wagering excessively (and facing bankruptcy) versus wagering conservatively (and forgoing substantial returns).
How you allocate capital across trades separates consistent winners from those who deplete their accounts. The Kelly Criterion — a mathematical framework introduced by John Kelly, a researcher at Bell Labs, in 1956 — calculates the theoretically ideal stake size for compound wealth growth over time. Let us examine its application within prediction markets.
The Kelly formula
For a two-sided prediction market (YES/NO), the Kelly fraction is expressed as:
f* = (p * b - q) / b
Where:
- f* = percentage of total capital to allocate
- p = your assessed likelihood of success
- q = likelihood of failure (1 - p)
- b = decimal odds (return per unit wagered). For a conditional token trading at price c, b = (1 - c) / c
Worked example
Suppose you assess a 60% probability that an outcome resolves affirmatively. The 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 in USDC, you would stake $272 on this position.
Why full Kelly is dangerous
The Kelly formula presupposes perfect knowledge of your true winning probability — an assumption that never holds in practice. Miscalculating your edge upward causes severe overexposure. Experienced market participants therefore employ fractional Kelly:
- Half Kelly (f*/2): The standard choice among professionals. Surrenders roughly 25% of theoretical gains whilst cutting drawdown volatility in half
- Quarter Kelly (f*/4): Prudent strategy when your edge confidence is low
- Capped Kelly: Establish a ceiling of 5-10% per market regardless of what the formula suggests
Applying Kelly to multi-market portfolios
Once you hold stakes across several prediction markets at once, individual Kelly percentages require recalibration. The aggregate of all Kelly fractions must remain at or below 1.0 (your full bankroll). Practically speaking, restrict combined exposure to 50% or less, preserving dry powder for emerging opportunities.
When Kelly does not apply
Kelly presupposes you can reliably estimate your true success rate. Several circumstances violate this assumption:
- Unprecedented events lacking historical data or comparable cases
- Linked markets (e.g., presidential election outcome and Senate control are not statistically independent)
- Markets where you possess no informational advantage relative to the broader consensus
PolyGram supplies an integrated Kelly Criterion calculator for sizing positions before execution. The analytics suite encompasses payoff visualisations and maximum loss projections. Start trading on PolyGram →