What is Risk of Ruin in Trading?
The Risk of Ruin is a mathematical concept that calculates the probability that a trader will lose a specific amount of capital (the "ruin threshold") before achieving their growth targets. Ruin does not necessarily mean losing 100% of your account; in prop firm challenges, losing 5% to 10% constitutes ruin, and for retail accounts, losing 50% is often considered a point of no return.
Mathematical Logic
The Risk of Ruin depends on three main variables: your strategy's win rate, its reward-to-risk ratio, and the size of your risk relative to your ruin threshold:
If your expectancy value is negative, you will eventually reach ruin. If your expected value is positive, the risk of ruin decreases exponentially as your capital units (Threshold / Risk Size) increase. This is why keeping your risk per trade small (e.g. 1% instead of 5%) dramatically reduces your probability of blowing the account.