Kelly Criterion seems to me very stylized and even unrealistic framework (given its assumptions), which has extremely limited applied use. I was wondering whether you are aware of any real-life trading strategies which are backed by Kelly Criterion? If so, could you please discuss a bit how Kelly Criterion was applied?
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When reading Systematic Trading by Carver, he doesn't exactly explain the mathematics behind using Kelly criterion. He just states that Kelly criterion is used in volatility targeting.
How he uses it in volatility targeting is via the Sharpe ratio. Say for example you computed an annualized expected return of 8.0%, then you would like to keep the Sharpe ratio at 1.0 and set the volatility target that does so. Therefore, the annualized volatility acceptable would be:
$$Volatility\,Target = \frac{Expected\,Return}{Sharpe\,Ratio} = \frac{8.0\%}{1} = 8.0\%$$
But then he goes onto say that this is not very good because risk itself is not symmetric and instead asymmetric, so a better use for Kelly criterion is half Kelly criterion instead, which becomes:
$$Volatility\,Target = 0.5*\frac{Expected\,Return}{Sharpe\,Ratio} = 0.5*\frac{8.0\%}{1} = 4.0\%$$
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$\begingroup$ There are articles on the internet where people have modified the kelly criterion framework so that it can be used for position sizing when making bets on individual stocks. I haven't read them carefully and don't know if the techniques are helpful but the articles are out there. If you need help finding them, let me know and I'll try to help. $\endgroup$ Commented Sep 4 at 20:42
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$\begingroup$ I also don't know if the same techniques are used in industry or even by these individuals. Sometimes an article is just that: an article. $\endgroup$ Commented Sep 4 at 20:43
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$\begingroup$ @EvanSemet the whole point is about volatility targeting to set your level of risk. If you decided to use full Kelly criterion and set your Sortino at 1, the volatility target must reflect the downside risk. I don't really understand how you can use Sortino if you don't get to use downside risk as an input in the first place. $\endgroup$ Commented Sep 5 at 2:48
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$\begingroup$ KaiSqDist: On re-reading the question, it's not clear whether Sane was referring to volatility targeting or position sizing ? They are related but not really that similar. Maybe he meant any application of Kelly ? $\endgroup$ Commented Sep 5 at 10:12
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$\begingroup$ @markleeds it is any general application of Kelly criterion to trading. $\endgroup$ Commented Sep 5 at 11:59