This article is part of the WSJ Investing Challenge email course.
Knowing how much to bet can be just as important as knowing what to bet on. This insight applies not just to gamblers but also to investors allocating their funds.
See if you can make the right decisions in this baseball simulation.
In this game, you are betting on your favorite baseball team, which has a 57% chance of winning whenever they play (that happens to be the historical winning record of the New York Yankees).
You have $100 to wager on the next 10 games and can choose how much of your fictional cash pile to wager on each game. For example, if you bet $20 in round one and the team loses, you will lose that $20 and be left with $80. If, however, the team wins (and they have a 57% chance to do so), then you will get your $20 back and also win $20, thus increasing your cash pile to $120.
You can choose a different amount to bet for the next round.
The game will end after 10 rounds or if you lose all of your money — whichever comes first. Play ball!
Round 1 / 10
Odds of Winning: 57%
The game you just played is very similar to an experiment published in 2016 by Victor Haghani and Richard Dewey. In that experiment, Mr. Haghani and Mr. Dewey gave 61 college-aged students and young professionals–most of them focused on economics or finance–the opportunity to bet a total of $25 for 30 minutes on coin tosses biased to land on heads with a 60% probability. The maximum payout was $250 in real money.
That’s even better odds than in this game, but one-third ended up with less money in their accounts than they started with and 28% went bust. Only about one in five players ended up with the maximum possible payout, despite the fact that most everyone would have profited by employing a consistent, calculated betting strategy.
The fact that we chose sports betting as a way to teach you about how much or how little to risk is no coincidence. The formula for how much to wager was derived by Bell Labs scientist John Kelly and was initially applied to gambling. The so-called Kelly Criterion has been cited by some of the world’s savviest investors such as Warren Buffett and Bill Gross.
Mathematically, the Kelly Criterion tells you what percentage of your capital to put into a single trade taking into account the odds and your historical win/loss ratio. In practice, it can save investors from their own enthusiasm, keeping them from making too many concentrated bets and going bust.
The equation is below, but don’t get wrapped up in the math – you aren’t a high-stakes gambler. The point is to have a consistent strategy that is neither so reckless that you could suffer a painful loss nor so small that you barely move the needle.
Percentage to bet = Odds – (1-Odds/Your win/loss ratio)
You weren’t guaranteed to come out ahead by betting on 10 Yankees games, even though they had a 57% chance to win each game. But the Kelly Criterion would help ensure you didn’t lose your entire pot while making the optimal bet in every round, which is 14% of your bankroll in this case, according to the formula. Shhh … don’t tell people who haven’t played yet!
- Writing: Laura Forman
- Game concept and design: Spencer Jakab, Robin Kwong
- User interface design: Andrea Pappas
- Software development: Caitlin Prentke
- Project management: Allison Foley
This is a newsroom innovation project.
Copyright ©2020 Dow Jones & Company, Inc. All Rights Reserved. 87990cbe856818d5eddac44c7b1cdeb8