Skip to content
All library documents

Risk of Ruin: Applying Gambling Models to Trading

Article Quant Q&A · Author: Tom Tucker
Read the original

Summary

The document raises questions about whether risk of ruin (ROR), a concept associated with gambling, can describe trading losses and whether a zero probability in a published table means ruin is impossible or merely very unlikely. It also asks how win rate and payoff ratio enter an edge-based ROR calculation. The example cited is a book’s claim that a specified win rate and payoff ratio produce zero ROR, while a formula found by the author relates edge and capital units to ruin probability.

No derivation, worked calculation, or answer to these questions is included, so the document does not establish when the formula applies or how its assumptions fit real trading. It is best read as a prompt for examining how outcome probabilities, payoff sizes, and available capital shape ruin risk. Any conclusions would require clarifying the model’s assumptions and limits, which the post leaves open.

Key ideas

  • The document asks whether gambling-based risk-of-ruin concepts can be applied to trading.
  • It questions how to interpret a reported zero ruin probability.
  • It asks how win rate and payoff ratio determine the edge used in a ruin calculation.
  • The post presents questions and a candidate formula but does not derive or validate them.

Tags

Risk managementPosition sizingStatistics
Full text
# How to Calculate Risk of Ruin


# How to Calculate Risk of Ruin












I'm reading a book titled "A Trader's Money Management System" and it discusses risk of ruin(ROR) tables. It says that you can have a zero probability of ROR with a payoff ratio of 2 to 1 and a win rate of 60%.

- My understanding is that the concept of ROR originated in gambling, but is it applicable to trading and more importantly, does it work in real world trading?

- The book says a zero percent probability of ROR means that ruin is extremely unlikely, but not impossible. Doesn't that go against the definition of a zero percent probability?

- How do you calculate ROR? The book only includes a sample table. I googled it and this came up. `((1 - Edge)/(1 + Edge)) ^ Capital_Units` How do you fit the payoff ratio and the win rate into the edge?

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.