✅ Capital management or Money Management.
🐹Let's imagine you're trading. You only have $100 and you want to make money on cryptocurrency. But in order to earn capital, you have to be a master in preserving your existing capital. That’s why you need a guide to managing your money.
💸You want the money to last as long as possible, and you do not want to destroy all your capital with one or more failed deals. Consider that your 100 dollars is your full bankroll (100 dollars are selected only for the following examples in the text. This will apply if you have 5, 6, 7, 8 or even 9 digits of net value).
❗What is the optimal bet size (trade size) that maximizes profit, but protects against falling in case you make a mistake?
Meet John Kelly and the Kelly criterion. The Kelly criterion, first proposed by Professor John Kelly, calculates how much of his net assets should be put on the horse to maximize the expected logarithmic capital gains. This criterion will tell you how much you have to bet on each trade so that you never go bankrupt.
So, let's go back to our example of $100.
Let’s look at the difference in the expected result if you make 1,000 trades and each time you bet 1%, 2% and 4% of your bankroll, respectively.
In other words, if you bet 1%, you risk $1 on the first bet. If you lose 10 trades in a row, your total portfolio is now worth $90 (and therefore your bet is now $0.90, which is 1% of your overall portfolio).
💼 As the rate increases, the profit also increases.
But you can also see that the volatility increases as your bet increases.
For example, the figure shows that after 590 bets (bet size 4%) you actually lost $50, which is equal to 50% of your portfolio overload, while the 1% overload is barely less than $100.