In this guide
Key takeaway: The Kelly Criterion determines the optimal proportion of your capital to deploy on each bet, accounting for your edge and available odds. In prediction markets, it solves two critical problems: excessive risk exposure (which can lead to account depletion) and under-allocation (which sacrifices potential returns).
Bankroll management separates consistently profitable traders from those who lose everything. The Kelly Criterion — a mathematical framework introduced by John Kelly, a researcher at Bell Labs, in 1956 — calculates the theoretically optimal stake size for maximising compound growth over time. This guide explains how to implement it 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* = proportion of total capital to allocate
- p = your assessed likelihood of a winning outcome
- q = likelihood of a losing outcome (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 event concludes YES. The current market quote stands at 45 cents (reflecting 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 Kelly formula recommends deploying 27.2% of your capital. If your account holds $1,000, you would stake $272 on this position.
Why full Kelly is dangerous
The Kelly formula presupposes perfect knowledge of your true win probability — a condition that never exists in practice. Miscalculating your informational advantage can trigger severe overbetting and account ruin. Institutional traders and sophisticated market participants favour fractional Kelly approaches:
- Half Kelly (f*/2): The industry standard. Trades away ~25% of theoretical growth in exchange for 50% lower volatility
- Quarter Kelly (f*/4): Prudent choice when your edge assessment carries substantial uncertainty
- Capped Kelly: Establish a hard ceiling (typically 5-10% of total capital) per individual market, overriding Kelly output if necessary
Applying Kelly to multi-market portfolios
When you maintain concurrent positions across several prediction markets, individual Kelly allocations require portfolio-level adjustment. The aggregate of all Kelly fractions must remain at or below 1.0 (your entire bankroll). Practically speaking, target total deployment below 50% to preserve dry powder for emerging opportunities.
When Kelly does not apply
The Kelly framework depends on reliable probability estimation. Several scenarios undermine this assumption:
- Unprecedented or highly ambiguous events (situations lacking comparable historical data)
- Interdependent markets (such as presidential election outcomes and legislative control, which are not statistically independent)
- Markets where your analysis provides no advantage relative to prevailing market consensus
Use PolyGram's integrated Kelly Criterion calculator to calibrate position sizes ahead of each trade. The platform's risk management suite encompasses payoff visualisations and drawdown metrics. Start trading on PolyGram →