# 3 PROVEN Ways To Avoid RISK OF RUIN (Risk Management Trading) ðŸ”¥ðŸ”¥

– Welcome to the video series on Money Management In Trading. In this series, I

will be covering money management

and risk management in great depth. In this particular part,

I will be discussing one of the most important

concepts in money management, that is importance of

knowing risk of ruin. After finishing this part, you will have a

good understanding of how not to lose

your entire capital while trading. So lets get started. This entire series

about money management and risk management is

structured in such a way that you can understand

the importance of capital preservation while maximizing your profits. Now, many beginners who

come to the stock market do not understand the importance of money management in success, and therefore I have

dedicated an entire series towards this topic. So, in case you are

one of those traders who has lost money in the market this is the concept

which will help you understand why you have

lost money till now. I’ve also suggested

three solutions for you so that you can implement

this in your own trading and eliminate the risk of ruin in your own trading account. Now, calculating risk

of ruin is pretty simple and I have shared the

formula in the video, but in case you are not

familiar with Microsoft Excel, then do let me know in

the comment section below and I will email the

Excel sheet to you. So risk of ruin is perhaps the most important

concept in trading that is not spoken

about that often. This is one concept

that every trader should be aware of and

yet I find very few books and tutorials mention this

on a consistent basis. So this is precisely why

this is the first topic I will cover in this Money

Management In Trading series. The reason why risk of

ruin is so important is because it will

help you understand why you have lost

money till now. In simple terms, risk of ruin is a statistical measure

that tells a trader the odds of losing so much money which will eventually

lead one to stop trading. Now do note here

that risk of ruin does not mean losing

100% of capital. For some of traders

it will just mean losing 50% or even

60% of capital. Now this varies from

trader to trader and this mainly depends

on risk tolerance level. Now, there are couple

of ways to calculate risk of ruin and

this is something we will cover in

subsequent slides. Let me first show you one

of the most effective ways to quickly determine

risk of ruin and then to make necessary

changes to avoid it. The formula to

calculate risk of ruin is given in front of you. In this formula, W stands

for winning percentage, L stands for losing percentage, and N is the units of money in trading account. So W and L are wining

and losing Percentage of your own trading strategy. The most simple way

to determine this is to refer to

historical back test data of your own trading strategy. Now I’ll recommend

for you to analyze at least three years of

historical back test data to determine the stats

for winning percentage and losing percentage. Let me now explain

what N stands for. So let us assume your

account size is of 100,000 and you decide to

risk 5,000 per trade. N would then be

calculated as account size divided by risk per trade. So in this case value

of N would be 20. Let me now take another example to understand risk of

ruin calculation better. In this example, I have

taken a trading strategy which has winning

percentage of 56% and 44% is the

losing percentage. Since account size is 100,000 and risk per trade is 5,000, there are 20 units of money

available for trading. If you take these values

and put it in this formula risk of ruin would

come about at 1%. As a trader, you should

aim for risk of ruin to be as closer to

zero as possible. In my own experience I’ve found that reading above 4% does not work in the long run. Now that you’ve understood

the basics of risk of ruin, let me now show

you three main ways that you can aim for

your own risk of ruin to be as close to

zero as possible. The first way to

avoid risk of ruin is to reduce the size

of risk taken per trade. In this chart, I have

taken six traders who trade with the same system which has winning

probability of 45% and losing probability of 55%. Each trader, if you

see, has account size of 100,000 but risk

per trade is different due to their own risk profile. Trader one, if you see, has two units of

money available, followed by Trader two,

three, four, five, and six who have five units,

10 units, 15 units, 20 units, and 25

units respectively. Do remember here that unit

of money is calculated by dividing the account size

by risk taken per trade. Based on how much each

trader risks per trade, Trader one has 67% odds of losing all of his money. Trader two and Trader three have 36% and 14% odds of same. Now do take a look at

Trader four, five and six, each of these traders

have just 5%, 2% and 1% odds of losing

entire capital. The main reason for this

is that they are risking limited amount of

money per trade, which in turn is helping them to preserve their capital

over the long term. At this stage of your

life, if you are someone who is repeatedly

losing lot of money, then begin by reducing

risk per trade right away. See at this stage you

have to understand that your number one priority is not to make

money in the market. If you are beginning

in stock market, then your number one

priority has to be to always protect your capital. Now even after

having some amount of experience in market, my number one rule in trading is to always look

after my capital. I’m never bothered

about profits, I’m never bothered

about losses. The number one priority for

me when I get up each day is to protect my

capital at all costs. The second way to

avoid risk of ruin is to trade a trading strategy that has high odds of success. In this chart, all

traders that you see here have account size of 100,000 and all are risking

10,000 per trade. Unit of money available

to each trader is 10. That is account size

divided by risk per trade. Based on this chart,

Trader one trades with a trading strategy

that has 51% win ratio. If you look at risk

of ruin for Trader one it stands at 67%. Similarly for Trader two,

with win ratio of 53%, risk of ruin stands at 30%. Now take a look at Trader

five and Trader six. With win ratio of 60% and 65%, their odds of risk of ruin is just 1.7% and 0.2%. So as win ratio of a

trading strategy improves, it is less likely for a trader to lose his capital. I hope this point is clear. At this stage, do

compute win ratio of your own trading strategy, and in case your win

ratio is less than 50%, then either shift to a

strategy with high win ratio or start reducing

your risk per trade so that you can sustain for a longer time in the market. So till now you know

how to calculate risk of ruin based

on win-loss ratio and units of money available. Let me now show you how

to calculate risk of ruin based on capital and

maximum draw down of a system till date. So do note here that

maximum draw down is the maximum loss from

high to low in a portfolio and this remains a key metric to track in risk management. The formula to

calculate risk of ruin is given in front of you where W stands for

winning percentage, L stands for losing percentage, and N is defined

as total capital divided by maximum

draw down till date. Now this way of

calculating risk of ruin is also good as this

takes into account your win-loss ratio along

with the capital available and draw down based on

your own trading strategy. In this example,

win ratio is at 53%, and loss ratio is at 47%. Total capital under

consideration is 50,000 with maximum draw down

till date of 5,000. So the value of N in this case is 50,000 divided by 5,000, that is 10. Now when you put

all these values in the formula given here, risk of ruin percentage

comes out to be 30%. So at this stage

I hope you can see why recording all your trades is so important in stock market. Unless you get into the

habit of documenting all your trades in a journal, you will never be

able to compute risk of ruin metrics. The main reason for this is

you will require statistics on winning percentage,

losing percentage, and maximum draw down of

your own trading strategy. So my recommendation

for you will be to document every trade

that you take in detail. Now the third way to

avoid risk of ruin is to trade a strategy

that has limited draw down. In this example, all

traders are trading a different strategy

that has win ratio of 51% and capital for each

trader is at 50,000. Trader one has a maximum

draw down of 5,000 till date and his risk of

ruin stands at 67%. Trader two, if you see, has

maximum draw down of 4,000 and his risk of

ruin stands at 61%. Similarly for Trader

three, four and five, risk of ruin stands

at 51%, 37% and 14%. Now take a look at

Trader six here. Trader six has a

maximum draw down of 500 and therefore his risk

of ruin is at 2% only. So in this particular example, as amount of draw

down decreases, odds of risk of

ruin also decreases. Now as a trader, you can have

maximum draw down of 5,000 and still lower your

risk of ruin below 2%. For this to happen

though, your win ratio would have to be closer to 60%. I hope you can

see how win ratio, risk per trade and draw down impact the risk of

ruin for a system. Your aim here has to be

to use a trading strategy that finds a balance

between all these variables that we have discussed. This way, you will

reduce your odds of risk of ruin drastically. So let me now explain

how you should be proceeding forward from here. Now that you understood the

concepts of risk of ruin you should now

calculate risk of ruin for your own trading strategy. For this you will

require win-loss ratio, risk per trade, and the

draw down statistics. In case you do not have the same I would strongly

recommend for you to test at least

three years of data. Your entire focus here should be to bring your risk

of ruin below 2%. Now, once you’ve

computed your results in case you need

feedback about the same, then do let me know in

the comment section below.