Risk of Ruin: The Math Behind Going Broke
Risk of ruin is the probability that a string of losses wipes out your account, and it falls dramatically when you keep risk per trade low.
Risk of Ruin: The Math Behind Going Broke
You can be a profitable trader and still go broke — if you size your bets wrong.
Risk of ruin is the probability that a string of losses will reduce your account to zero (or to a point where you can no longer trade). It's the number that separates "profitable strategy" from "strategy I can actually trade."
The formula (simplified)
For a strategy with an edge, the approximate risk of ruin is:
Risk of ruin = ((1 − edge) / (1 + edge)) ^ units
Where edge is your per-trade advantage and units is your account expressed in risk units (account ÷ risk per trade).
Example: $10,000 account, 1% risk ($100) = 100 units. Edge = 0.05 (5% advantage).
RoR = ((1 − 0.05) / (1 + 0.05)) ^ 100 = (0.905) ^ 100 ≈ 0.004%
That's a 0.004% chance of going broke — essentially zero.
What changes risk of ruin
| Risk per trade | Edge | Risk of ruin |
|---|---|---|
| 1% | 5% | ~0% |
| 2% | 5% | ~1% |
| 5% | 5% | ~30% |
| 10% | 5% | ~80% |
Two takeaways:
- Risk per trade is the dominant lever — doubling it doesn't double risk of ruin, it squares it
- Even a positive edge can ruin you if you size too aggressively
The 1%–2% rule explained
Most risk rules exist to drive risk of ruin toward zero, not to maximize returns. The 1%–2% rule works because:
- At 1% risk, you need ~100 consecutive losses to blow the account
- At 2%, ~50 losses
- At 10%, just 10 losses — and 10-trade losing streaks happen to every strategy
A 10-trade losing streak at 1% risk leaves you down 9.6%. The same streak at 10% risk leaves you down 65% — and that's without compounding psychology.
Why edges aren't guaranteed
Risk of ruin assumes your edge is real and stable. In practice:
- Edges decay as markets change
- Edges are estimated, not known
- Execution costs erode the real edge below the backtested one
If your true edge is half what you think, your risk of ruin can be 10× higher than calculated. Treat edge estimates with skepticism.
Practical rules
- Cap risk at 1%–2% per trade — use the position size calculator
- Track losing streaks in a journal — if your real streaks exceed backtested ones, your edge estimate is too optimistic
- Reduce risk during drawdowns — many pros halve risk after a 10% drawdown
- Diversify across uncorrelated setups — multiple independent edges cut risk of ruin multiplicatively
- Never martingale — increasing size to recover a loss sends risk of ruin toward 100%
The honest truth
A strategy with a real edge and 1% risk per trade is, mathematically, almost impossible to blow up. The traders who go broke don't lack an edge — they lack discipline on size. Risk of ruin is the math that explains why position sizing is the most important skill in trading.