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risk of ruin

The chance that a losing run empties the account so far that it cannot recover.

Risk of ruin is the chance that a run of losses shrinks an account so much that recovery becomes impractical. It depends on the size of each loss, how often losses occur, and how much money remains.

A losing streak does not need to reach zero to cause trouble. If an account falls from $10,000 to $5,000, it needs a 100% gain just to return to $10,000. Smaller, consistent risks leave more room to withstand an ordinary bad run, but they cannot remove risk.

Example

Nora practices with a $10,000 account and sets a possible loss of $100 per trade, or 1% of the starting balance. Five losses in a row cost 5 × $100 = $500, leaving $9,500. If instead each loss were 10% of the then-current balance, the sequence would be $10,000 → $9,000 → $8,100 → $7,290 → $6,561 → $5,905. The fifth loss leaves about $5,905, not zero, but getting back to $10,000 would require about a 69% gain ($4,095 ÷ $5,905). Neither sequence predicts what will happen; they show how risk size changes the damage.

Common mistakes

  • Thinking a small risk makes ruin impossible. A long enough losing run or other costs can still do serious damage.
  • Using the starting balance for every percentage calculation. If the risk is a share of the current account, the dollar amount changes as the balance changes.
  • Ignoring the recovery math. A 50% loss needs a 100% gain to get back to the starting balance.
  • Treating a probability estimate as a promise. The assumptions and future sequence can differ. Most people who trade lose money.

Learn it in the course