Jim Leitner On Sizing Bets & Investment Portfolio Construction
The following are notes from various lectures Jim Leitner has given on his investment strategy and process.
Bet Sizes
Leitner is a big fan of using the Kelly criterion to size his positions. The Kelly criterion calculates the max amount you can bet on your edge without going broke from a bad run.
- Knowing the Kelly bet size is important to prevent yourself from turning a positive EV bet into a negative one through the use of too much leverage.
- Always err on the side of caution. Be conservative instead of aggressive.
- You can go broke being over-aggressive.
- You can’t go broke being over-conservative.
- The max amount Leitner has ever bet is half the Kelly number. Since we’ll never know the true probabilities of a trade, it’s rare to bet more than half the Kelly bet.
where:
- f* is the fraction of the current bankroll to wager, i.e. how much to bet
- b is the net odds received on the wager (“b to 1”); that is, you could win $b (on
top of getting back your $1 wagered) for a $1 bet - p is the probability of winning
- q is the probability of losing, which is 1 − p.
Portfolio Construction
Leitner thinks of a portfolio as a collection of (hopefully) positive expected value trades. Taking more than one trade at a time should lower your overall risk through diversification. But you have to make sure each bet is uncorrelated. Otherwise you could end up with a portfolio that’s just one large bet.
- The more uncorrelated the better.
- Leitner uses a bloomberg terminal to estimate correlations between each asset.
- There are three kinds of correlations: (0) (1) (-1)
- A 0 correlation is ideal. It’s a completely independent bet, but it’s also tough to find.
- If all your bets are losing or winning together, then you’re probably not playing with independent bets. Adjust accordingly.
Example:
The Kelly bet says to bet 30% of your money. You use half of that for safety, so now it’s down to 15%. Divide that 15% by 10 to get total portfolio level risk of 1.5% per trade.
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