Risk of Ruin: The Probability of Blowing Up Your Account

Risk of ruin is the probability that a strategy loses so much that you can no longer continue: the account hits zero, or a drawdown so deep you would stop trading. A strategy can have a positive edge and still have a meaningful risk of ruin if each bet is too large.

What drives it

Three things matter most:

1. Your edge: win rate and payoff ratio together. See expectancy.
2. Risk per trade as a share of the account.
3. Your definition of ruin: losing 100%, or a smaller threshold like 50% that would end your trading in practice.

Of the three, risk per trade is the one you control directly, and it has the largest effect.

An intuition

Imagine a coin flip that pays 1.2 to 1. It has a small positive edge. If you bet 50% of your account each flip, two losses in a row leave you with 25%, and a few more finish you, despite the edge. Bet 1% per flip and you would need a long, extremely unlikely streak to lose half the account.

Estimating it with simulation

Closed-form formulas for risk of ruin exist for simple cases, but trading results are messy. A practical method is Monte Carlo simulation:

1. Take your actual trade results in R.
2. Shuffle them randomly thousands of times to create alternative histories.
3. Apply your risk per trade to each history.
4. Count how many histories hit your ruin threshold.

This uses your real distribution of wins and losses, including the occasional large loss.

Ways to lower it

• Lower risk per trade. The single most effective lever. See the 1% rule.
• Avoid oversized outliers. One 10R loss can do more damage than a streak of 1R losses. Use hard stops and size down around events.
• Reduce size during drawdowns.
• Avoid correlated positions that turn several bets into one. See correlation risk.
• Improve the edge, which takes the longest but helps the most over time.

Ruin is not only financial

For most traders, the practical ruin point is psychological. A 40% drawdown may not empty the account, but it often ends a trader's confidence and discipline. Define ruin as the drawdown you could not live with, and size so that it is very unlikely.

Try it

The free Kelly's Simulator runs simulations of many trades at different risk levels so you can see how often an account falls below a threshold. TradeThink's statistics give you the inputs: your win rate, payoff ratio and R distribution.