Section: Advice > Money Management

Money Honey - The First and Last Word on Money Management
by Peter Ruchman

Part Two - Lemme Tell You 'Bout Machine Gun Kelly...

There is hope. The remarkable and brilliant Huey Mahl, a true handicapping genius who passed on in 1996, wrote in his 1988 broadsheet, Universal Money Management Plan, "Of all the money manipulation schemes I've investigated over the years, I have found none which could hold up to the vicissitudes of long-term play as well as the properly controlled Proportional Bet (emphasis is his), and not only optimize the return, but protect your investment base from ruin. The mathematical proof was developed by John Kelly, Jr., a Bell Labs engineer, back in 1956. You've probably heard his treatise referred to as the Kelly Criterion."

In Kelly's system of betting, you always bet a fixed fraction of your bankroll. The faction you choose is proportional to that which will maximize its earning potential, or growth rate. In this model, you bet 5% of your bankroll, with a starting total of $2000.00. Your first bet of $100 wins, so you now have $2100, so your second bet is $105. If that wins, your third bet becomes $110.25. If, on the other hand, your first bet loses, you would lose the $100, leaving you with $1900 operating capital, and the second bet becomes $95. Nothing fancy here, no astounding scores, but no shocking losses either. The Kelly Criterion is built on the concept that the more you have to bet, the more you'll risk, but you'll remain proportional to a fixed percentage that will minimize your risk of ruin and maximize your opportunities to win.

In his fine book on casino and sports betting odds, Can You Win? Mike Orkin writes that, "Statistician Leo Breiman showed that the Kelly system is optimal for two reasons. First, it will do better in the long run than any substantially different strategy. Second, the expected number of bets necessary to reach a specified goal with the Kelly System is lower than with any other strategy."

The finest part of this system is that it disciplines you to bet the same percentage, thereby minimizing your chances of going broke. And your bankroll has a decent opportunity of growing at a modest but desirable rate. Betting 5.5% of your bankroll on each bet, with a series of 100 bets, at a 55% win rate, your bankroll would increase by 15%. Returning to our starting bank of $2000, that would mean a gain of $300. Obviously, betting at a higher percentage, or increasing your win rate will significantly raise your growth rate. For example, with a win rate of 65%, betting 26% of your bankroll, in 1000 bets, $2000 will grow to more than $50,000.

Is there a downside to the Kelly Criterion? Of course (but you guessed that.) This model works only with bets made offering a favorable win expectation. Applied to situations where the house has a built-in edge, Kelly goes right down the tubes. Huey Mahl set the formula for this model as W % minus L%/ P (to $1) where W%= the percentage of winners; L%= the percentage of losers, and the denominator P (to $1) is the average amount won per dollar.

The way Huey figured it, you want to use the Kelly model in gambling situations where the handicapper has distinct and favorable odds. It is easy to see how this formula will eventually wear down the bankroll with diminishing results in unfavorable conditions. Using this system, you will never hit the big one. But, the chances of a complete disaster are minimized as well.

Those Low-Down Gamblin' Ways

Gambler's Ruin: A term bleak enough to make anyone shiver. Send a real player into the depths of despair. In fact this term is applied to money management when, a player is involved with games having a negative expectation, the smaller the bet in relation to the size of the bankroll, the greater the chance of going broke. An example might be if a gambler has a bankroll of $1000 and he's looking to double his money; he decides to divide the bankroll into units of 200 at $5 each. His chance of going broke is 94.4%. I'd take the over he's going to lose it all. If, on the other had he takes the whole shebang and make one large bet, he has an almost even chance to double his money.

The opposite holds true in situations where there is a positive expectation. In this situation, the smaller the bet in relation to bankroll, the better the chance to increase the money.

Mathematical probability laws are based on large samples occurring over a long duration. This is a reminder of the good old "due" factor. When a team, or hand, or situation wins over a short period of time, these unfortunate souls start betting against it, because they think there is a short-term inevitable opposite about to present itself. Therefore, rather than minimizing a losing streak by stopping or lowering their bets, they increase, expecting the opposite, based on the "law of averages." Concurrently, instead of maximizing a winning streak, they back down, fearing the worst. Mathematicians call this "The Doctrine of The Maturity of Chances." Without meaning to appear redundant: Each event of chance is completely independent of everything preceding it or following it.

"When you make a bet at less than the correct odds, which you always do in any organized gambling operation, you are paying the operator a percentage charge for the privilege of making the bet. Your chance of winning has what mathematicians call a "minus expectation." When you use a system, you make a series of bets, each of which has a minus expectation. There is no way of adding minuses to get a plus, or adding losses to show a profit. "

"Add to this the fact that all gambling operators, including race and sports bookies, limit the size of the player's wagers so it is impossible to double up bets indefinitely. This and the house percentage make all gambling systems worthless."

This from long-time casino expert John Scarne. He goes on to note that the only exception is in games where skill and chance are involved and this allows the player to make bets with a positive expectation. If you have a power rating that indicates a team should be the favorite, and the offered betting line makes its opponent the favorite, you have value, referred to as an overlay, and thus a positive expectation. In blackjack, if you are a card counter, and the count goes plus, you have a positive expectation. In poker, if you are aware of your opponents' tendencies, you can use that to an advantage given the right situations, for a positive expectation.

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