What is risk of ruin?
Simply put, risk of ruin is the probability that an investor will lose a large amount of money based on a certain trading method or strategy. It is important to figure out your risk of ruin. If you plan on making a living out of trading, then you need to know if your strategy will keep your account afloat for the long term. That is why we are providing this handy risk of ruin calculator.
How to calculate risk of ruin?
Calculating risk of ruin is relatively simple but requires a lot of iterations to perform the calculations. That is why it is vital to have a calculator that performs those iterations for you. To use our risk of ruin calculator you just need five pieces of data. Account Balance, percent risk on each trade, number of trades, average reward ratio, and your max acceptable draw down. Let’s run you through an example below:
Suppose you want to play Black-Jack. You have $1000 to spend. If you are looking to make your money go as far as possible, then you would want to have some kind of plan in order to mitigate losses, while maximizing profits. You have determined before-hand you only want to risk one percent of your account with each hand. You also only want to risk a maximum loss of 25% of your money. After playing ten hands, you win three out of those ten times, or 30%. That last piece of data we need is your profitability. Each of your winning hands earned you 200% profit. That’s everything we need to calculate risk of ruin. See our result image below.
Based on this calculation you would have an 85.8% chance of hitting your max drawdown, and a 58.6% chance of ruining your accout. If you have a low appetite for risk, then you may want to adjust your strategy a bit.
As you can see, this calculator is a good indicator of the strength of your trading system. Our free risk of ruin tool would be great if you have a new strategy you want to test to see if it can be profitable, while also minimizing risk.
Our free trading tool is also great if you have strategy that you’ve been using for a while. Adjusting the numbers to find a desirable drawdown could make your strategy more profitable by reducing your downside potential.
So what is the ideal amount of risk I should be taking?
Ultimately, that question can only be answered by you based on the strategy that you trade. The market you are trading in could also play a role in your risk tolerance. We do have a few suggestions, so take notes.
1) Keep your risk percentage proportional to your account size. Also, how important is that money to you?
Are you trading with a $500 account? Maybe 5% is acceptable to you, that is what we could define as a ‘small’ account. BUT, is that your life savings in that small $500 account? Well then, maybe you should only risk 1% or .5% instead. There could be any number of variables that could change the amount of risk you take per trade. Additionally, if you’re trading a $500,000 account you may only risk .1% or .05%. Just a fraction of what you would with a small account.
2) Keep your win % in mind when choosing your risk %
Are you winning 75% consistently taking smaller gains? Maybe you can risk a little bit more. Or are you in the 30% win range while take larger profits? Maybe you should risk a bit less.
3) Finally, be dynamic.
If you’re going through a season where you seem to be hitting all your trades with smaller losers, then you may be able to increase your appetite for risk given the consistency. But what happens when you hit a losing streak? Probably time to cool the engine down a bit, and decrease your risk load.
Remember, the key to surviving in trading is longevity. There are always going to be ups and downs in the market and your portfolio. Trading is and always will be a marathon, not a sprint. Keep these tips in mind, and it will help set you up for a lifetime trading journey.
Now, try this trading tool software for yourself
Our risk-of-ruin calculator is a handy, simple to use tool that will help you make better trading decisions. Understand the everyday risks you take based on your current trading strategy. It will give you insight into whether your system is likely to be profitable or not.
How to use the Risk of Ruin Calculator
Fill in the inputs of the risk of ruin calculator following the instructions below:
1) Win Rate
The win rate is simply your win percentage. To calculate this simply divide your number of winning trades against your overall number of trades taken. Example, you take 100 trades and win 60.
60 / 100 = .6 or 60%
2) Average Profit/Loss
Average Profit/Loss is the average amount of money your wins have over your losses. In other words, your average winner divided by your average loser. For example. If you average $100 risk per trade, and you average $200 per trade you divide your average winner against your average loser.
200 / 100 = 2
3) Risk/Trade
Risk Per Trade is the average amount of money you are risking on each trade. Successful traders tend to be consistent with the amount they are risking on each trade. They will typically risk 1% – 5% on each trade depending on account size. Larger accounts may want to risk less than 1%, but this number is ultimately up to the trader to decide. The more consistent you are with your risk percentage, the more accurate your risk of ruin calculation will be.
4) Number Of Trades
Following our risk per trade, the next input is Number of trades. This input is very simple. All you need is the number of trades that you’ve taken to make the calculations for risk of ruin. The higher the number of trades you’ve taken, the more accurate the risk of ruin calculation will be.
5) Max Draw Down
The final input box for the risk of ruin caluclator is Max Draw Down. This is the maximum amount you are willing to let your account go down in value. This is a worst case scenario value. Let’s say you have a $10,000 account, and your goal is a max draw down of 25%. That means in the worst case scenario your account value may drop to $7500 dollars. But, assuming your strategy is successful, and your risk level is appropriately optimized, it should be extremely unlikely that you could reach your max draw down. See below for an explanation on how to interpret the results of this free trading tool.
What does the Risk of Ruin Calculator Result Mean?
When you click the calculate button, you will get two values. First, is the risk of peak-to-valley draw down. Second, is the actual risk of ruin. Both numbers are very similar but it’s worth noting the slight variance between the two.
Risk of peak-to-valley draw down
This is the probability that you will hit your max draw down from an equity high. If you are successful in your trades, and you see large peak forming on a chart of your trade performance, this just determines the likelihood that you reach your maximum draw down after a successful run of trades.
Risk of ruin
This number is your overall percentage risk of hitting your max draw down regardless of what kind of equity highs/lows you’ve experienced.
Now go ahead and try the risk of ruin calculator for yourself.
Simply fill in the form below, and see your results for yourself. Feel free to play around with our free tool. You may be able to optimize your risk, and ultimately help provide your account with draw down protection.
