How to Size Individual Positions Using Kellyesk Formula
It’s over a year since I read any of the articles I linked in yesterday piece on the Kelly formula and portfolio management. After reading the brilliant article by Michael Mauboussin Size Matters – The Kelly Criterion and the Importance of Money Management I realised that both he and I did not explain how to actually use the Kelly formula in sizing individual positions. So let’s try to fix that glearing omission.
I’ve now copied a few more columns from my portfolio spreadsheet to yesterday’s Kelly Spreadsheet. As I stupidly never documented my reasons for using these formulas, the following is my best guess and why I choose them.
Geometric Mean: As I am in the market for the long term, have no intention of withdrawing funds and will compound my investment I choose geometric mean instead of the average (also known as mean or arithmetic mean). For a discussion on this read the Mauboussin article.
Percent of Portfolio: This calculates what percent of my portfolio I should invest in one position. Based on dividing the geometric mean by the sum of the geomeans.
Actual Percent of Portfolio: Let me stress again all the figures in my example are made up. However, I do hold positions in all of the stocks except Microsoft. This column is exactly what it says on the can. The actual percent of my portfolio that I have invested in that stock.
Adjust Actual: This is the amount I need to change my investment to align my actual with my calculated amount.
Hopefully that makes it clearer how I use a Kellyesk Formula to determine my individual position sizing in my portfolio. If not please feel free to ask questions. Also, please note that I do not solely rely on the expected return, reward/risk, geomean or percent of portfolio to determine my actual investment. I consider them all and then use my gut for a final decision. Perhaps as time goes on I’ll get more comfortable relying solely on one or a combination of those calculations, but I’m not there yet. However, I have found these calcuations incredibly helpful for both my buying and selling of indivudal stocks. I hope you also do.