Transcript

Today I’m going to show you exactly how much money to put into each trade to maximize your potential wins.

Last time I had several fat stacks of cash. Well, bad news. I’m down to this quarter. But this quarter can help us figure out what to put into each position using something called the Kelly criterion.

If we flip this quarter, we’ll get a 50% chance of heads and a 50% chance of tails. But what if this quarter, every six out of 10 times, we knew that it would land on heads?

That would change things.

And using the formula that I’m going to show you, you would learn that you would put 20% – just 20% – of your money on heads every time. You would never on tails, always on heads, and put 20%.

I’m going to put a formula on the screen now. It’s going to look complicated, but it’s really not.

This is the Kelly criterion, and we need just two reliable indicators to go into this equation. Let me show you them here.

We have a W and an R. The W is really simple. That’s our win probability. That’s the historic proportion of trades that we’ve made that have led to a gain.

If we have 50 trades and 25 of them are winners, the number here would be 0.5. If we have 75 trades out of a hundred, that are winners, it’d be 0.75.

We go into our R. That’s our win loss ratio. And this is pretty important because you can lose $500 and only win $250 on each trade.

But as long as you’re winning more, really in this way twice as much as losing, you’re going to make out ahead.

In our example here, we’re just going to just say that for every trade we make $500 and our losers are bigger and we lose $1,000. That gives us an R here of 0.5.

When we do the math and plug all this in, pretty simple math, we get a Kelly number of 10%. That’s key.

That tells us that for every trade, sticking with our system here, that for every trade, we invest 10% of our money in each of those trades.

This is why it’s absolutely critical to keep a trading log.

You want to know, using your strategy, don’t change that strategy once it’s working, you want to know how many trades are winners, how much you’re winning, how much you’re losing and how many trades are losers. Because then you can go do some simple math, use the Kelly criterion and know exactly what you can put into trades and get out ahead in the long-term.

Using the Kelly criterion has been proven that you will not go broke doing this.

This strategy was taught to me by a guy who beat Las Vegas, essentially got kicked out of Las Vegas by the mob and went to Wall Street where he flat out dominated Wall Street for 30 years using ratios and models, just like this.

I’ll talk to you next time.