Risk & Money ManagementProbability of Ruin
Risk of Ruin
The probability that an account will lose a defined portion of its capital before reaching a chosen profit objective.
What Risk of Ruin means
Risk of ruin estimates the chance that a trading account is destroyed, where ruin is defined in advance as some threshold such as losing half the starting capital or breaching a maximum acceptable drawdown. The probability depends on four inputs: the win rate, the ratio of average win to average loss, the fraction of capital risked per trade, and the number of trades considered. Of these, the fraction risked per trade is by far the most influential, and the relationship is steeply non-linear.
The practical use is as a sanity check on position sizing, most often by resampling a real trade history through Monte Carlo simulation to see how often randomised orderings breach the ruin threshold. Two caveats limit the output. The models assume trades are independent and drawn from a stationary distribution, whereas correlated open positions and shifting market regimes both violate that. Real risk of ruin is therefore consistently higher than any model suggests, which argues for treating the modelled figure as an optimistic floor.
Worked example
A break-even system with a 50 percent win rate and a 1:1 payoff will eventually breach any fixed drawdown threshold given enough trades, so its risk of ruin approaches 100 percent; cutting risk from 5 percent to 1 percent per trade on a system with a genuine edge can move modelled ruin probability from double digits to a fraction of 1 percent.
Related terms
- Money ManagementThe set of rules governing how much capital is risked per trade, per day and across all open positions.
- Risk Per TradeThe share of account equity a trader is prepared to lose on a single position, normally expressed as a percentage.
- DrawdownThe decline from a peak in account equity to a subsequent trough, usually stated as a percentage of the peak.
- Maximum DrawdownThe largest peak-to-trough equity decline recorded over a given period of trading or testing.
- Kelly CriterionA formula giving the fraction of capital to risk per trade that maximises the long-run growth rate, given a known edge.
Frequently asked questions
What does Risk of Ruin mean in forex trading?
The probability that an account will lose a defined portion of its capital before reaching a chosen profit objective.
How does Risk of Ruin work in practice?
The practical use is as a sanity check on position sizing, most often by resampling a real trade history through Monte Carlo simulation to see how often randomised orderings breach the ruin threshold. Two caveats limit the output. The models assume trades are independent and drawn from a stationary distribution, whereas correlated open positions and shifting market regimes both violate that. Real risk of ruin is therefore consistently higher than any model suggests, which argues for treating the modelled figure as an optimistic floor.
What is an example of Risk of Ruin?
A break-even system with a 50 percent win rate and a 1:1 payoff will eventually breach any fixed drawdown threshold given enough trades, so its risk of ruin approaches 100 percent; cutting risk from 5 percent to 1 percent per trade on a system with a genuine edge can move modelled ruin probability from double digits to a fraction of 1 percent.
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