Risk of Ruin
The probability that a trading or betting strategy eventually loses enough to become unrecoverable, given its edge, position sizing, and variance.
Risk of ruin is the calculated probability that a given trading strategy, played out over enough attempts, eventually experiences a loss severe enough to become practically unrecoverable — driven by the combination of the strategy's statistical edge, how much is risked per attempt, and the natural variance in outcomes.
Position sizing that ignores risk of ruin can make an otherwise statistically favorable strategy fail in practice, since a large enough string of losses, sized too aggressively, can wipe out capital before the strategy's long-run edge has a chance to play out. See Kaavon's "Understanding Risk of Ruin" guide for the full calculation and its inputs.
Examples
- Two traders with an identical statistical edge can have very different risk-of-ruin outcomes purely based on how much each risks per trade.
- Reducing position size is one of the most direct ways to lower a strategy's risk of ruin, independent of improving its underlying edge.