Appreciating The Risk Of Ruin by Nauzer J. Balsara
Traders focus on developing trading rules and systems that identify market entry and exit points. A factor that is often overlooked is the percentage of trading capital available that is risked on trades. This article analyzes the risk of ruin by varying three parameters using a Monte Carlo simulation. The results can help you determine your chances of success.
A trader is said to be ruined if his or her available capital falls below the minimum required to trade.
The risk of ruin is a probability estimate ranging between zero and 1. A probability estimate of 0 suggests
that ruin is impossible, whereas an estimate of 1 implies that ruin is assured. The risk of ruin is a function
• The probability of success
• The payoff ratio, or the ratio of the average win to the average loss on completed trades
• The fraction of capital exposed to trading.
In its most elementary form, the formula for computing the risk of ruin as defined by statistician William
Feller makes two simplifying assumptions: that the payoff ratio is 1 and that the entire capital in the
account is risked to trading.