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## Chris DeMuth Jr's Library: Fortune's Formula [View article]

I think Chris is gracious on his answers to your questions. In my experience, it is to my advantage to understand and practice using the Kelly formula. There are a lot of opinions in the web; it is up to you to figure which is the truth and which is the voodoo science.

(1) "The formula is particularly unsuited to markets where probabilities are unknown."

If the probability is unknown, why do you trade it? Trading unknown is really "gambling" (in a bad sense).

(2) "Too many traders try that silly trade a bunch of stocks thinking they are diversified."

This has to do with diversification. In fact, the right way is that Kelly should be applied to a strategy, not to a stock. Overtrading highly correlated stocks is a violation to Kelly to start with.

(3) "Everybody and their grandma thinks they have an exploitable "edge" which leads to inappropriate use of the formula in the first place"

Yes, Kelly specifically tells you that if you don't have an edge, don't trade it.

(4) "There's plenty of information out there on the web that demonstrates the Kelly formula is the sure way to lose all your money even in games that ARE appropriate for it."

My experience is just the opposite. It is a sure way to lose money if a trader doesn't understand the danger of overtrading. The Kelly formula helps on that aspect.

Just a bit of my background. I trade part time and mostly options. I am grateful to the Kelly formula as a wonderful tool for saving me from "blowing" up my account.

## An Investing Strategy That Is Half Warren Buffett And Half Nassim Taleb [View article]

## Asset Allocation In The Eyes Of The Kelly Strategy, Part II [View article]

Thanks for reading my articles and providing feedback.

(1) I am in agreement with your remark on a small data sample does not make sense applying the Kelly formula. For monthly, this data series has approximately 300 data points. For yearly or multiple years, I am using monthly looking forward 1, 3, 5 years etc, so there are still approximately 250 data points. I agree that this data series does not have longer enough time span. I wish I have data date back say 1920's. It would be interesting to see how the calculation holds.

(2) The main reason for me to choose Kelly is to answer the question how much asset I can allocate to a particular strategy. I mostly trade options, so the biggest fear is overleaveraging and "blow up" my account. I use Kelly to "curb my enthusiasm" both on the way up and on the way down. I usually calculate Kelly on my total trades (of the same strategy), and on my last 100 trades (to monitor the time drift effect), and choose the lesser of the two. It is interesting to see that if I have a series of bad trades, my Kelly ratio drops quite quickly and tell me to stop trading. So to a degree, I think my practice with Kelly is a way of anti-Martingale. On a longer timeframe, Kelly could act as Martingale (if I choose to believe I should take the bigger Kelly ratios of the two).

(3) I also agree with your comments of modifying the formula; I haven't yet figured out how so inputs are very appreciated. Meanwhile, I fully acknowledge Kelly is an approximation, but in my opinion it is a good one and a convenient one.

Lastly, my Kelly articles were inspired by my view that many investors are overleveraged without knowing they are overleveraged, even naively holding SPY. Hope I got my point crossed.

## An Investing Strategy That Is Half Warren Buffett And Half Nassim Taleb [View article]

This is where many option traders lose money. The JNJ LEAP is actually cheap; other trades are even more expensive.

## An Investing Strategy That Is Half Warren Buffett And Half Nassim Taleb [View article]

I think I get the "black swan" now. If it is just the outliner points, there is nothing to be concerned about. It is part of randomness. There are ways to manage it.

## An Investing Strategy That Is Half Warren Buffett And Half Nassim Taleb [View article]

To answer your question if I hedge naked put, I don't hedge the trade itself per se, but I hedge with different strategies and more importantly, position sizing. To scale it, my average loss per "blow-up" is 2% of my portfolio. Once a while, I may have a 4% or 5% "blow-up", but certainly manageable. There is a remote possibility that if SPY goes to zero tomorrow, I will be completely wiped out. But, if SPY goes down 10% in one day, I will be ok and still have enough dry powder to fight another day.

So, back to "black swan". If I understand your point correctly, the "black swan" is the outliner point outside the 99% confidence internal (as per Taleb?). Then, I think he managed to scare the readers rather than to educate the readers. A simple 90/10 indicates the "risky" strategy is not very effective. As a concrete example, I will only allocate 10% of my portfolio to a strategy that gives me 1:1 payout ratio with 55/45 odd. If there is a better strategy, should we increase the 10% allocation?

## An Investing Strategy That Is Half Warren Buffett And Half Nassim Taleb [View article]

## An Investing Strategy That Is Half Warren Buffett And Half Nassim Taleb [View article]

I have some experiences in trading options; selling put is my favorite tactics. Based on my limited knowledge, I believe that if one to trade options randomly, regardless buy or sell options, at the end he will come up even (not counting small loss due to commissions and slippage).

This is both the beauty and the Achilles' heel of the option pricing model. how does an option trader make money? While the aggregate market is efficient, there are special situations that are not efficiently priced. Exploring those situations adds the alpha for an option trader. As you suggested "preys on people's fear or uncertainty", what really happens is that people (or Mr. Market) willingly deviate from the random-walk model by discounting a future situation that may or may not happen. A "brave" (or "stupid") option trader picks up the other side of the trade and believe it will return to the random model.

A "black swan" (or what I called uncertainty) is something can not be predicted in advance. In real life, I think occurence of natural disaster or man-made disaster may qualify as "black swan". I could not figure out how the bar-bell strategy can be successful in taking advantage of the occurence of the "black swan". Being sarcastic for a moment, taking the bar-bell strategy to an extreme, one should put 90% of his asset under the mattress and spend the 10% buying powerball. That's where I have trouble to understand how to trade a "black swan" situation.

## An Investing Strategy That Is Half Warren Buffett And Half Nassim Taleb [View article]

## An Investing Strategy That Is Half Warren Buffett And Half Nassim Taleb [View article]

IMO, uncertainty is not a tradable event. Since you can not predict or foresee, how can you bet on it? In contrast, randomness is where the money is generated. If the main design behind the bar-bell strategy is the "black swan", i.e., uncertain occurence, how can we be certain it is a winning strategy?

Again, I am not against Taleb and his writing; I think he tried quite hard to distinguish them. But, I just have trouble to wrap my head around a strategy of trading uncertainty. Maybe you can enlighten me?

## An Investing Strategy That Is Half Warren Buffett And Half Nassim Taleb [View article]

I think even Taleb tried to explain the difference, but it was lost in the context. Today, "black swan" has been used interchangably between uncertainty and randomness, which defeats the purpose of defining "black swan" to start with.

Just MHO.

## An Investing Strategy That Is Half Warren Buffett And Half Nassim Taleb [View article]

There are many ways to reduce the time premium. One possibility is to use deep ITM LEAP option.

## Chris DeMuth Jr's Library: Fortune's Formula [View article]

## Chris DeMuth Jr's Library: Fortune's Formula [View article]

One other thing I want to point out is that the Kelly formula alone does not create the "edge"; it is basically an optimization solution if you have an edge. If you don't have an edge, the Kelly formula won't help.

## Chris DeMuth Jr's Library: Fortune's Formula [View article]

The essence of the Kelly formula is to balance the potential for gain with the reserve for loss, which is very applicable to both active and passive investing methods. This is an essential tool for any investors.