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Trading Strategies
The Risk-Constrained Kelly Criterion: From the foundations to trading
Optimal bet sizing using Kelly Criterion
Kelly Criterion Overview
The Kelly Criterion is a well-known formula for allocating resources into a portfolio, ensuring maximum long-term return for trading strategies. However, traditional Kelly Criterion can lead to significant drawdowns that are unacceptable in real trading scenarios.
To overcome these limitations, Busseti et al. (2016) introduced the risk-constrained Kelly Criterion that maximizes long-term log-growth rate while incorporating drawdown constraints, resulting in smoother equity curves with reduced risk exposure.
This approach balances optimal capital allocation with risk management, making it more practical for real-world trading applications where drawdown control is essential for sustained performance.