What Is Risk of Ruin?
Risk of ruin is the probability of losing enough capital that you can no longer trade effectively. The exact threshold varies — some define it as losing 100% (account blown), others as losing 50% (can't recover psychologically). Risk of ruin is primarily a function of how much you risk per trade relative to your edge — even with a positive expectancy, risking too much can lead to ruin through an unlucky streak.
How Risk of Ruin Works
The math is unforgiving: risking 10% per trade with a 50% win rate gives a significant probability of ruin even with positive expectancy. Risking 2% per trade with the same edge makes ruin virtually impossible. The Kelly Criterion provides the theoretical maximum bet size, but half-Kelly or quarter-Kelly is used in practice to reduce the risk of ruin to negligible levels.
Why It Matters for Traders
Risk of ruin should be the first calculation before live trading. The question isn't "how much can I make?" but "what's the probability I blow up?" Position sizing rules exist to keep risk of ruin near zero — typically below 1% per trade. If your risk of ruin is above 5% over any reasonable time horizon, your position sizing is too aggressive, regardless of how good your strategy is.
