Advanced risk: risk of ruin, Kelly and equity stops
- What risk of ruin is and what drives it
- What the Kelly formula suggests, and why to use a fraction
- How equity stops protect you from the unexpected
Risk of ruin
Risk of ruin is the chance that a strategy loses enough to end your trading (for example, a 50% drawdown). It depends on three things: your edge, your win rate and, above all, your risk per trade. With a modest edge, risking 1% gives a very small risk of ruin; risking 10% makes ruin likely even with a good edge.
The Kelly formula
Kelly gives the bet size that would maximise long-run growth if your statistics were known exactly:
W = win rate, R = average win ÷ average loss. Example: W = 0.45, R = 2 → 0.45 − 0.55 ÷ 2 = 0.175, or 17.5% per trade.
17.5% per trade would be wildly aggressive in practice. Your real statistics are uncertain, and full Kelly produces huge drawdowns. Professionals who use Kelly at all use a small fraction of it, often a quarter or less, and many simply cap risk at 0.5–2%.
Equity stops
An equity stop pauses trading when the account falls a set amount from its peak (for example 10%). It's a circuit breaker for situations the strategy wasn't designed for: a regime change, a bug, a broker problem.
Try it: what recovery costs
Other limits worth having
- A maximum total open risk (e.g. 4%).
- A daily and weekly loss limit.
- A maximum number of trades per day.
- Betting full Kelly on estimated statistics.
- Having no equity stop "because the strategy is proven".
- Watching per-trade risk but not total open risk.
How this works when you copy trades
Check yourself
- Risk per trade is the main lever on risk of ruin.
- Kelly is a ceiling, not a target: use a small fraction or a fixed cap.
- Equity stops and total-risk limits are circuit breakers.