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Risk & Money Management

What Is Risk of Ruin

Risk of ruin is the chance that a run of losses carries the account down to a chosen line it cannot come back from, and what sets it is the share risked a trade, which fixes how many losses in a row reach the line. This paper shows you the line at half a 10,000-dollar account and the runs that reach it, 69 losses at one per cent a trade and 7 at ten; the idea as a fence set back from a cliff edge; what a fair coin does, seven tails in a row once in 128 tries and sixty-nine almost never; two piers of seven and sixty-nine planks over the same water; and the longest run the account has actually had, in the report on your platform.

Difficulty
Intermediate
Reading time
5 min
Pages
8
Reviewed by
Saman Rahbar

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The ruin line, and the runs that reach it

Risk of ruin is the chance that a run of losses carries the account down to a line it cannot come back from. The line is chosen, half the account here, 5,000 of 10,000 dollars, and the arithmetic says how long a run reaches it: 69 losses in a row at one per cent a trade, 35 at two, 14 at five, 7 at ten. The third column is for a fair coin, not a market, and says only how rare a run of that length is when nothing is wrong. Seven tails in a row come up once in 128 tries; fourteen once in 16,384; sixty-nine almost never. The share risked decides which of those runs is the one that ruins.

A fence set back from the cliff

Picture a fence set back from a cliff edge. The edge is the account gone; the fence is the ruin line, put well before it; and each loss is a step towards the fence. Risk of ruin is the chance of taking every step to the fence before any step back. The share risked a trade sets the size of the step: at ten per cent the fence is seven steps away, at one per cent it is sixty-nine. The fence is in the same place either way. What changes is how many losses in a row it takes to reach it, and a run of seven is an ordinary thing while a run of sixty-nine is not, on a coin or on anything else.

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