Risk of ruin
The probability of losing the account with your settings. Calculated in advance, not after the fact.
Risk of ruin — what it is?
Risk of ruin is the probability of losing the account given your risk settings and trade statistics. It is a computable quantity, not a matter of opinion.
It depends on three things: the risk percentage per trade, the risk-to-reward ratio and the win rate. Of those, you fully control only the first.
The numbers come out vivid. At 1% risk with positive expectancy the probability of ruin is close to zero; at 10% per trade it becomes almost inevitable.
Risk of ruin — how it is built?
There is one practical consequence: the risk percentage is the only lever that reliably governs survival. Do not raise it hoping to speed up growth — the effect on speed is linear, and on risk of ruin exponential.
Risk of ruin — common mistakes
Believing that positive expectancy protects you from zeroing the account.
Increasing risk after a run of winning trades.
Ignoring correlations: five positions at 1% in related instruments is one position at 5%.
Judging risk of ruin by feel.
Related to
Glossary
- risk-to-reward ratio
- the distance to the take divided by the distance to the stop.
- win rate
- the share of profitable trades. On its own it says nothing about the result without the R:R.
- Expectancy
- the average result of one trade given the win rate and the average size of a win and a loss. The main measure of a strategy.
- close
- the last price of the period. Considered the most important of the four: breakouts are confirmed by the close.
- correlation
- how closely two instruments move together. Positions in strongly correlated instruments are effectively one position of a larger size.
- position
- an open trade.