Risk of Ruin
You will sometimes come across the concept of Risk of Ruin (RoR) in discussions of risk management and trading system evaluation. Simply stated, the RoR is the chance of blowing out your account. Each of us has a different idea of what exactly that means, so the RoR will vary from trader to trader.
For example, assuming two traders use the same trading system in the exact same manner, the trader who considers “ruin” to be losing 50% of the account or portfolio value, would have a higher RoR than the one who views “ruin” as meaning a 75% loss. After all, it is less likely that you will lose 75% than 50% (at least we hope so!).
The RoR is mostly discussed when evaluating trading methods, but is tied very closely to risk and money management strategy. The more you are putting at risk on a per trade basis, the higher your RoR is going to be, all other things being equal. Other factors which contribute to the RoR determination are win rates and average win vs. average loss figures.
We are not going to spend much time with RoR, however we want to present it at this stage, because it does tie in with our earlier talk about per trade risk and how even a system with a high win rate can still result in bad results if too much risk is taken. It also goes hand-in-hand with the drawdown. After all, ruin is the worst kind of drawdown.
Posted: under Chapter 2.
Related articles
- Initial Words (February 14th, 2007)
- Risk Tolerance (February 14th, 2007)
- Loss Recovery (February 14th, 2007)
- Timeframe & Trade Frequency (February 14th, 2007)
- Trade Risk Management (February 14th, 2007)