kelly-position-sizing_skill

Overview

This skill implements position sizing based on the Kelly criterion to optimize long-term capital growth. It provides formulas, practical adjustments, and portfolio-level extensions to translate theoretical Kelly fractions into actionable trade sizes. The focus is on maximizing geometric growth while controlling short-term risk through fractional Kelly, volatility, correlation, and concentration adjustments.

How this skill works

It computes base Kelly fractions from expected excess return and return variance (f* = μ/σ²) or the discrete-binary formula for bet-like outcomes. The skill applies practical caps and multipliers (half, quarter, etc.) and supports multi-asset optimization using μ'w - (1/2) w'Σw. Dynamic adjustments account for volatility, correlation with existing holdings, used capital, and confidence levels. It includes monitoring guidance to re-estimate parameters and rebalance.

When to use it

• Sizing positions when you have quantified expected excess return and variance
• Allocating capital across multiple opportunities with known covariances
• Converting theoretical optimal bets into conservative trade sizes (fractional Kelly)
• Adjusting exposure during regime changes (rising volatility or concentration)
• Stress-testing portfolios and setting practical caps to avoid ruin

Best practices

• Use conservative parameter estimates and prefer fractional Kelly (1/2, 1/4, 1/8) for noisy signals
• Cap nominal position sizes (e.g., 100% of portfolio) and enforce remaining-capital checks
• Adjust Kelly by realized vs average volatility and by correlation to existing portfolio
• Recalculate μ and σ² regularly and run scenario/ tail stress tests for fat tails
• Implement execution rules: build in tranches, set stop loss thresholds, and log deviations

Example use cases

• A value investor estimating scenario-based μ and σ² to derive a conservative quarter-Kelly position
• A quant allocating across assets using multi-asset Kelly with a covariance matrix and risk constraints
• A trader reducing base Kelly when current market volatility exceeds historical averages
• A portfolio manager limiting new positions to remaining capital after accounting for existing exposures
• A venture investor using 1/8 Kelly for highly uncertain startups to preserve capital while testing ideas