John Kelly = Gambling Life Guru

Introduction

One of the most important things you learn as an advantage gambler is the Kelly Criterion(Kelly). It ties all APs together, whether they play blackjack, bet sports or battle it out on the poker felt. The cross-discipline nature of the Kelly Criterion should tip us to it's importance.

But I think it goes further than gambling. I am going to make a case that the framework John Kelly gave us is most valuable in our everyday lives.

What is the Kelly Criterion?

The Kelly Criterion is a formula that determines what % of your wealth (bankroll) you should bet on a single opportunity. It wants to maximize the growth rate of your bankroll without ever going broke. You need to know the following to use it properly:

- The size of your bankroll

- The payoff (odds) of your bet

- The % chance you will win (in practice, usually unknowable)

I will not write the formula here - as we don't need it for this thought exercise. What we need to know are the two "Laws of Kelly" that build a robust mental framework.

- If the payoff stays the same, but the chance you will win increases: Bet more

- If the payoff increases, but the chance you win stays the same: Bet more‍

Pretty simple - reverse them and get the criteria for "Bet Less".

What does Kelly teach us about certainty?

When using the formula, you must input the % chance you have to win. If you are flipping a fair coin, this is easy. Your chance to win is 50%. If you are betting on the outcome of a sporting event, it becomes much more complex. Predicting real-world events is a game of guessing. The true probability is never known, and the person who guesses closest to the true probability will win.

In these gambling games, we combat this by cutting down the recommended stake by 50% or more. Betting 50% of the recommended Kelly bet size is known as betting "half-kelly". Betting a fraction of Kelly is such common practice in advantage play that anyone betting "full-kelly" will be regarded with concern.

But why do we fluctuate the % of Kelly we bet? It should be fluctuated with certainity in your win %. Flipping a coin you could bet full Kelly if you weigh the coin and check it is as fair.

But picking a poker game to buy-in to is tougher. You have to make assumptions about your opponents skill that you can never fully know. So you air on the side of caution to avoid disaster.

This leads us to the third "Law of Kelly"‍

The more confident you are that you are right, the bigger you should bet.

What is the goal of Kelly?

The final piece to the puzzle is what Kelly solves for us. The point of Kelly is to maximize bankroll growth per bet without ever going broke over infinite bets.

The Fourth Law of Kelly:

Kelly maximizes growth without violating a non-negotiable condition (in this case going broke).‍

If you break Kelly down to it's components - you can create a framework more useful than any I have come across in self-help or business books.

‍The four laws of Kelly are:‍

1. If the payoff stays the same, but the chance you will win increases: Bet more.

2. If the payoff increases, but the chance you win stays the same: Bet more.

3. The more confident you are that you are right, the bigger you should bet.

4. The goal is to maximize growth without violating a pre-determined, non-negotiable condition.

Application of Law 1: If the payoff stays the same, but the chance you will win increases: Bet more.‍

There are a lot of situations where you cannot affect the payout (that much). Let's say you are in the interview process for two jobs and you have no preference (payout = the same).

But you used to work with someone who is part of the hiring committee at Job A.

John Kelly would probably tell us to invest a larger % of our time/ focus to Job A - as our likelihood of getting the job is higher because of our connection.

Application of Law 2: If the payoff increases, but the chance you win stays the same: Bet more.

This is what I like to call the "pick the right game" law.

Consider a perspective poker player who wants to play cards for a living. They read an old book on 7-card Stud and love the game. In a few years they become the best 7-card stud player in the world - and make...$100,000 a year?

Now consider they took a different path. They saw No Limit Hold'em on TV. They study, start at low stakes and work their way up. In a few years they become the 200th best No Limit Hold’em player in the world and make...$500,000 a year?

Choosing to specialize in 7-card Stud today would be like starting a newspaper business. No matter how good you get, you won't make the big bucks (yet it's still hard to get really good!).

Make sure you have the right "opportunity vehicle" so that you get rewarded for the hard work you are putting in

Application of Law 3: The more confident you are that you are right, the bigger you should bet.

The "do what you know" law of Kelly. It can run against law number 2 at times. For example:

Let's say someone has spent 10 years working in kitchens and training to become a chef. And they finally decide "I want to start a business"

Should they start a restaurant or a tech company? Well, a tech company has a higher payoff. But this person should have 0 confidence in their business plan for the tech company. They should have way more confidence in an idea they developed for a restaurant.

Not just because they know how to cook - but because they have worked in the industry for a decade. They have way more valuable data on restaurants than tech companies.

Application of Law 4: The goal is to maximize growth without violating a pre-determined, non-negotiable condition.

Finally - the "do what you want" law. Kelly operates within the framework of avoiding going broke at all costs.

What do we want to avoid at all costs?

Some that I want to avoid:

• Working in an office
• Failed marriage
• Not having control over my time
• Exploiting others

It's important to have things that matter more than money. So my personal Kelly equation will maximize for bankroll growth (make money) without violating the non-negotiables.

Conclusion

One of my favorite things to do when left alone with my thoughts is take gambling concepts and generalize them to life concepts.

Kelly is one of my favorites to ponder - since it is so much more than just an equation.