Risk of ruin is the probability that a trader will lose a specified percentage of their account (the "ruin threshold") given their trading statistics. Even a profitable strategy can lead to ruin if position sizes are too large, because variance can produce extended losing streaks. This concept is fundamental to professional risk management and separates successful traders from those who eventually blow up their accounts.

The calculation uses three key inputs: Expected Value = (Win Rate x Avg Win) - (Loss Rate x Avg Loss), Payoff Ratio = Average Win / Average Loss, and risk per trade as a percentage of account equity. The Kelly Criterion, Kelly % = Win Rate - (Loss Rate / Payoff Ratio), provides the theoretically optimal bet size for maximum growth, though most traders use half-Kelly or less for safety. The risk of ruin drops dramatically as risk per trade decreases.

For example, with a 55% win rate, $150 average win, $100 average loss, and 2% risk per trade, the expected value per trade is $37.50 and the payoff ratio is 1.50:1. This is a profitable edge, but the risk of ruin depends heavily on position sizing. At 2% risk per trade, the risk of ruin to a 50% drawdown is very low. However, increasing risk to 10% per trade with the same edge would dramatically increase ruin probability, demonstrating that even a strong edge cannot overcome reckless position sizing.