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Ruin threshold
The equity level at which the strategy can no longer be traded as intended.
Lesson · Trading Risk Management
Risk of Ruin
Estimate how strategy expectancy, payoff, risk per trade, and sequence variance affect the probability of crossing a failure threshold.
Core concepts
What to understand
Keep the process direct: define the risk, calculate it, and enforce the limit.
2
Path dependency
Outcome order affects whether the account reaches the threshold.
3
Simulation estimate
Monte Carlo results are scenario estimates, not guarantees or exact future probabilities.
Interactive lab
Change the risk conditions
Adjust the controls and read the market behavior and account impact after each change.
Risk of Ruin Lab
Synthetic educational data · no live market connection
RISK MODEL
Risk process
Apply it in order
Risk calculations should happen before the order is submitted.
Define ruin practically
Use the minimum equity needed for strategy size, margin, or personal tolerance.
Model realistic outcomes
Use net win rate, payoff, costs, gaps, and occasional larger losses.
Stress the assumptions
Increase loss clustering and reduce expectancy to test robustness.
Knowledge check
Check your understanding
Select one answer for each question. Feedback appears immediately.
1. What generally increases risk of ruin most directly?
Larger losses per outcome move equity toward the threshold faster.
2. Does positive expectancy guarantee zero ruin risk?
A positive average can still contain unfavorable sequences that cross the threshold.
3. What is a Monte Carlo result?
The output depends entirely on the modeled probabilities and payoff assumptions.
4. Risk 5% of current equity per trade, ruin defined as a 50% drawdown. How many consecutive full losses reach it?
0.95ⁿ ≤ 0.50 when n ≥ ln 0.5 ÷ ln 0.95 = 13.5, so 14 losses: 0.95¹⁴ = 0.488. At 1% the same threshold takes 69 losses (0.99⁶⁹ = 0.50): the risk percentage sets how ordinary a streak has to be to end the account.
Practical rules
- Use conservative expectancy assumptions.
- Include rare losses larger than the planned stop.
- Set risk low enough that bad sequences remain survivable.
Common mistakes
- Treating simulation output as certainty.
- Using gross backtest results without costs.
- Defining ruin only as a zero balance.
References
Official reading
The labs use simplified synthetic examples. These sources cover the underlying risk and execution concepts.
FINRA · Risk
Investment outcomes contain uncertainty that can negatively affect financial welfare.