Risk Of Ruin Ratio (Part II)

September 7th, 2009 | educational | forex educational

The following are four hypothetical trading scenarios using a risk amount of 2% of your trading account on each trade. You need to evaluate what percent of your trading account should be risked on each trade to avoid the risk of ruin.Learn forex trading. Get good forex training. Get Netpicks forex signals free for two weeks.

1. Your win ratio is 45%. Your payoff ratio is 1 to 1. Your capital at risk is 2%. In this case the Risk of Ruin (ROR) is 100%. However, you can reduce your capital at risk to 1% from 2%. Your ROR probability will change from 100% to something like 50%. The next thing that you need to do is to review your trading system to improve your payoff ratio to at least 1.5. This will bring your probability of ruin to zero.

2. Your win ratio is 35%. Your payoff ratio is 2 to 1. Your capital at risk is 2%. In this case, ROR probability is 16%. However, just by decreasing your percent of capital at risk, your ROR probability will change from 16% to almost zero.

3. Your win ratio is 25%. Your payoff ratio is 3 to 1. You capital at risk is 2%. In this case your ROR probability is 19%. However, you should have observed that your win ratio of 25% is too low. You need to review your trading system and increase it to at least 30%. This reduces the ROR probability to almost zero.

4. Your win ratio is 50%. Your payoff ratio is 3 to 1. You have 2% of capital at risk. In this case, your ROR probability is almost zero. These are the statistics for an advanced trader. In this case you could risk 10% of your capital and still maintain 0.2% risk of ruin.

The last figures are for expert traders only. For example, if your win ratio drops to 35% be sure to adjust the percent of your account you have at risk. Remember when you reach this level; be sure to change your trade size if your performance statistics dramatically change.

Sometimes you will need to focus on your win ratio and the number of winning trades you have. Sometimes getting risk in line is as easy as reducing the percent of risk you take on each trade.

Giving attention to your exit points may enable you to significantly improve your payoff ratio. If you are a trend trader, just staying in a profitable trend longer can boost your bottom line.

You can use another formula known as the, “Optimal f Formula”, to calculate the optimal fraction of capital to be risked. The figures that you will calculate using this formula will be more aggressive than the Risk of Ruin tables.

The optimal fraction f to be risked on each trade is as follows: f= [(A+1) x p-1]/A. In this formula, f is the optimal fraction to be risked on each trade. A is the average payoff ratio or the dollars earned to each dollar lost and p is the average win ratio.