THE BIG IDEA
With the start of the NFL season upon us along with the rise of “prediction markets” this is a good time to discuss a concept related to binary outcomes. It also has consequences for trading in the stock market.
Imagine you have the opportunity to bet on the flip of a coin, which is rigged to land on heads 60% of the time. You can keep flipping the coin as many times as you want or until you run out of money.
What would you do? First of all, hopefully you are betting on heads EVERY TIME! But how much of your bankroll would you commit to each flip of the coin?
If you bet too conservatively, you are wasting your advantage.
If you are too aggressive, you risk disaster. Betting everything you have on heads means you have a 40% chance of being immediately wiped out.
Or what if you decide to bet half every time? It could go like this:
You start with $100.
Flip 1: Heads, you win! You now have $150.
Flip 2: Tails, you lose. You now have $75.
Flip 3: Heads, you win! You now have $112.50.
Flip 4: Tails, you lose. You now have $56.25.
Flip 5: Heads, you win! You now have $84.37.
You have won on 60% of these five coin flips and yet you have lost money!
Well, there is a formula for maximizing your long-term gain in such a situation. It is known as the Kelly criterion and the formula itself is simple enough.
In our example, p is 0.6 and therefore q is 0.4. We assumed even odds (you win the same amount that you bet) and so b is 1.
It means the optimal amount to bet in this scenario is (0.6 × 1 - 0.4) / 1 = 0.2 or 20%.
Most people over-bet in this situation, failing to realize that losing half of your pot means that you then must double your money just to break even. And if you play the game long enough, you will inevitably encounter a string of tails.
Try it for yourself! At kellycriterion.org there is a coin flip game where you can do a simulation. Bet big and see how long you last! Remember, you have the probabilities on your side! 😁
When it comes to the stock market, we rarely, if ever, know for sure what our probability of winning is or how much we would gain or lose.
You could still estimate the parameters of the formula. This could come from backtesting your trading strategy and/or using pre-defined rules about how much you are willing to lose on an individual trade.
Professionals who really use this formula often do a “half Kelly”, meaning they take the result of the formula and divide it by 2, to account for the uncertainties in their estimates.
(If you are going to use this formula to determine how much of your portfolio to allocate to an investment and then you intentionally don’t use that number, then what’s the point? But we digress….)
For most of us, to be honest, it may not be worthwhile to go to all this trouble. However, you can still benefit alot from the lessons of the Kelly critereon:
It is more difficult than you expect to recover from a big loss
Good risk management is the key to survival
He unknowingly bet “everything” on a coin toss in No Country For Old Men
SEEN ON THE INTERNETS
The U.S. stock markets are closed on Monday, September 7th due to the Labor Day holiday. So this timely information from Jeff Hirsch of Almanac Trader might help you when the markets reopen on Tuesday.
Hirsch gathered the performance data for four popular indexes for the day after Labor Day and the next day after that. Regardless of which index you prefer, the averages from twenty years of data point to a down day on Tuesday followed by a bounce back on Wednesday.
More surprising to us is the trend in the more recent years. If the market goes up on Tuesday it will be the first time in a decade that the day after Labor Day has been positive.
NUMBERS ONLY
$524.14 | As of Friday, Dell Technologies (you may remember it as Dell Computer) is sitting at an all-time high of $524.14. Competitor HP made a 52-week high on Friday as well. |
+ 0.78% | Despite reports of the death of the software industry, the Dow Jones Software Index is nearly flat for the year. The index currently has a YTD gain of 0.78%. |
4 | Consumer Discretionary stocks (think Starbucks, Nike) are down 4 weeks in a row. Higher interest rates tend to be problematic for these stocks. |
SWINGEX INDEX
As of market close on: 4 September 2026
Swingy says: Use the long weekend to relax your mind and get ready for when conditions improve.
Learn more about how the Swingex Index works here.
WATCHER
Stocks highlighted here each week are not recommendations to buy or sell. They are provided as ideas for swing traders to follow up on with their own research.
MRNA (Moderna): Literally overnight, Moderna became one of the top performing stocks in the S&P 500 this year upon word that its approach to treating melanoma showed positive results.
Since then, the shares have been oscillating up and down on ever decreasing trading volume. The result of that trading action is a classical bull pennant chart pattern.
Prices more often escape the pennant by continuing higher. That’s the bet to make now on MRNA. We may see a jump from the current $145 level, perhaps even testing the $170 area in the near future.
Keep in mind that even if the price goes in the “normal” direction, sometimes there is a failure to launch and the shares could quickly go in reverse.
MRNA could begin going higher later this week, in anticipation of a presentation at the Morgan Stanley Global Healthcare Conference next Monday, September 14th. What they say there has the potential to generate an outsized move one way or the other in the stock.