What it means
Risk of ruin is the probability of losing so much that you cannot continue (for example a 50% loss, or a level you set). It depends on expectancy, win rate, payoff and, above all, the fraction risked per trade.
Why traders use it
The same sequence of trades produces very different paths at different risk sizes. Higher risk makes both the swings and the chance of hitting the ruin level much larger, even when expectancy is positive.
Chart examples
Same trades, two risk sizes
How to identify it objectively
- 1Define ruin (for example −50%).
- 2Estimate expectancy and the longest plausible losing streak.
- 3Simulate many random orderings of your trades (Monte Carlo) at each risk size.
- 4Choose a risk per trade where reaching ruin is very unlikely.
Bullish use
- 1Risk a small fixed fraction (often 0.5–1%).
- 2Keep it fixed through streaks.
Bearish use
- 1Martingale (doubling after losses) increases risk of ruin sharply.
- 2Oversized leverage turns normal streaks into ruin.
What confirms it
- A Monte Carlo test on your own trade results.
What invalidates it
- Sizing from available margin instead of from the stop.
How a hypothetical setup is built
Entry
Not an entry rule.
Stop
Size = (equity × risk %) ÷ stop distance.
Target
Keep the risk fraction low enough that the worst simulated streak is survivable.
A hypothetical illustration of how the concept is turned into a plan, not a recommendation. Practise it on a paper account first.
Related concepts
- Risk Management & StatisticsMaximum Drawdown
- Risk Management & StatisticsPosition Sizing
- Risk Management & StatisticsExpectancy
- Full guide on The TradeskillRisk Management and Probability
Historical testing
The diagram applies the made-up 30-trade sequence at 1% and 5% risk per trade. At 1% the low point is about −2.2%; at 5% it is about −14.9%. Here 5% ends higher, but with a longer losing streak the same sizing can be ruinous.
Limitations: when it fails
- Risk of ruin formulas assume independent trades.
- Real streaks can be longer than any sample.
- Fees and slippage reduce expectancy.
Knowledge check
Pick an answer to see the explanation. Nothing is saved.