Risk of ruin

Trader's Glossary · Process and risk

Definition. The probability that, with a given method and a given risk per trade, your capital falls to a level at which continuing is no longer possible or acceptable.

How it works

Even a method with an edge goes through losing streaks. The bigger the share of capital risked on one trade, the greater the chance that one ordinary streak leads to a deep drawdown. Risk of ruin depends on the edge, the distribution of results and the risk per trade.

Example

In a simulation of a hypothetical system with a small edge (45%, +1.5R, −1R), a 50% drawdown within 500 trades occurred in 0% of accounts at 1% risk per trade, in about 3% at 2%, in 82% at 5% and in every account at 10%. When the real win rate was 40% instead of 45%, 47% of accounts had a 50% drawdown at 2%. This illustrates the statistics; it's not a recommendation.

What to watch out for

You only ever know your edge approximately, so risk set on optimistic assumptions doesn't forgive mistakes. A 50% loss requires a 100% gain to get back to where you started.

More in Hetman Capital Club

Full article in the Club (in Polish): ☠️ Risk of ruin: the mathematics of a trader's survival.

You'll find the full explanation with graphics, examples and exercises in the 🖥️ Order flow atlas space, and its use in the live market in the 🔴 Live Room. Both are available to Club members (in Polish).

Educational content, not investment advice.