{"id":215,"date":"2015-04-19T15:25:49","date_gmt":"2015-04-19T05:25:49","guid":{"rendered":"http:\/\/li209-143.members.linode.com\/?p=215"},"modified":"2022-10-24T13:32:33","modified_gmt":"2022-10-24T03:32:33","slug":"riskofruin","status":"publish","type":"post","link":"https:\/\/bettersystemtrader.com\/riskofruin\/","title":{"rendered":"Do you know your Risk of Ruin?"},"content":{"rendered":"

Trading is a risky business and so many people who enter the trading world fail, losing large amounts of money in the process.<\/p>\n

Have you already lost a large sum of money or are you on the path to becoming another trading statistic? How do you know?<\/p>\n

Brent Penfold from IndexTrader.com.au, who has been trading successfully since the 1980\u2019s and was a guest in Episode 2 of the Better System Trader podcast here<\/a>, believes \u201cwhy people lose is essentially most people are clueless about this key concept, Risk of Ruin.”<\/p>\n

Are you currently trading a system with money management that is destined to fail? To find out, you need to calculate your Risk of Ruin and we’re going to show you how.<\/p>\n

What is Risk of Ruin?<\/h3>\n

Risk of ruin is the probability that you\u2019ll lose so much money you can no longer continue trading. This doesn\u2019t mean losing all of your trading capital, the ruin point is based on your own personal risk tolerance, so ruin to you could be 15%, it could be 50% or it could be 100%.<\/p>\n

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Risk of ruin is number one or the most important concept in trading \u2013 Brent Penfold<\/a><\/div>\n

Click To Tweet<\/a><\/p>\n

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Calculating your own Risk of Ruin<\/h3>\n

The risk of ruin formula published by Perry Kaufman and discussed here<\/a> and here<\/a> uses the probability of a win to calculate the risk of ruin:<\/p>\n

risk_of_ruin = ((1 – Edge)\/(1 + Edge)) ^ Capital_Units<\/p>\n

Edge is the probability of a win or the Win%.<\/p>\n

Win% is only one small component of strategy performance results and really needs to be considered along with the Win\/Loss ratio, or the size of the wins compared to the size of the losses, to give a true indication of how a strategy performs. There are many profitable trading systems that have a win% as low as 30% but the size of the wins are many times larger than the size of the losses so the strategy is still profitable over the long term.<\/p>\n

Including the Win\/Loss ratio in the Risk of Ruin calculation makes the formula much more complicated so Brent Penfold from Indextrader.com.au has kindly provided the Risk of Ruin simulator he\u2019s developed in Excel as a free download to Better System Trader podcast listeners. There is a link to download the simulator at the end of the article but let\u2019s run through it first to see how it works and how we can apply the results to our own trading.<\/p>\n

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Understanding risk of ruin actually gives you a line in the sand that says that you should not be trading – Brent Penfold<\/a><\/div>\n

Click To Tweet<\/a><\/p>\n

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Using the free Risk of Ruin simulator<\/h3>\n

When you open the simulator, there are a few values you need to enter based on your trading strategy. (If it prompts you to enable the macros you will need to say yes otherwise the simulator won\u2019t work).<\/p>\n

In this example I’ve entered the values for a trend following strategy:<\/p>\n