Risk of Ruin - Psychology and Money Management | futures io social day trading
futures io futures trading


Risk of Ruin
Updated: Views / Replies:33,352 / 124
Created: by Big Mike Attachments:41

Welcome to futures io.

(If you already have an account, login at the top of the page)

futures io is the largest futures trading community on the planet, with over 90,000 members. At futures io, our goal has always been and always will be to create a friendly, positive, forward-thinking community where members can openly share and discuss everything the world of trading has to offer. The community is one of the friendliest you will find on any subject, with members going out of their way to help others. Some of the primary differences between futures io and other trading sites revolve around the standards of our community. Those standards include a code of conduct for our members, as well as extremely high standards that govern which partners we do business with, and which products or services we recommend to our members.

At futures io, our focus is on quality education. No hype, gimmicks, or secret sauce. The truth is: trading is hard. To succeed, you need to surround yourself with the right support system, educational content, and trading mentors – all of which you can find on futures io, utilizing our social trading environment.

With futures io, you can find honest trading reviews on brokers, trading rooms, indicator packages, trading strategies, and much more. Our trading review process is highly moderated to ensure that only genuine users are allowed, so you don’t need to worry about fake reviews.

We are fundamentally different than most other trading sites:
  • We are here to help. Just let us know what you need.
  • We work extremely hard to keep things positive in our community.
  • We do not tolerate rude behavior, trolling, or vendors advertising in posts.
  • We firmly believe in and encourage sharing. The holy grail is within you, we can help you find it.
  • We expect our members to participate and become a part of the community. Help yourself by helping others.

You'll need to register in order to view the content of the threads and start contributing to our community.  It's free and simple.

-- Big Mike, Site Administrator

Reply
 41  
 
Thread Tools Search this Thread
 

Risk of Ruin

  #31 (permalink)
Elite Member
Northern Germany
 
Futures Experience: Intermediate
Platform: NT
Favorite Futures: FDAX, CL
 
vvhg's Avatar
 
Posts: 1,583 since Mar 2011
Thanks: 1,016 given, 2,801 received


Nasdin94 View Post
In short, keep your drawdown low.

The higher your drawdown, the more difficult it is for you to recover.
It is an exponential curve.

Very true but the statement is entirely qualitative. So it doesn't give me any quantitative statement what my risk of ruin is.
But as I have said before, I have no optimal solution to that problem either, so I am certainly not entitled to complain about statements that need not to be argued upon as they are obviously correct!

vvhg

Hic Rhodos, hic salta.
Reply With Quote
The following user says Thank You to vvhg for this post:
 
  #32 (permalink)
Elite Member
Berlin, Europe
 
Futures Experience: Advanced
Platform: NinjaTrader, MultiCharts
Broker/Data: Interactive Brokers
Favorite Futures: Keyboard
 
Fat Tails's Avatar
 
Posts: 9,598 since Mar 2010
Thanks: 4,222 given, 25,354 received
Forum Reputation: Legendary

Another Approach to the Risk of Ruin

I am not an expert on risk of ruin, but I will try to formulate some basic ideas. Be aware please that I am not insisting that the following statements are entirely correct.


Calculating the Risk of Ruin Requires A Few Assumptions


(1) I assume fixed fractional betting, that is for every bet (trade) I am betting the same fixed percentage of my account.

(2) Definition of ruin: Ruin is achieved, when you cannot trade anymore. Ruin therefore depends on the initial account size and the maximum acceptable drawdown.

(3) Target: If you want to quadruple your account, the risk of ruin is higher than if you just intend to double your account, as you stay in the game for a longer time.

(4) Bet size: The bet size has the largest impact on the risk of ruin. I will express the betsize as a multiple of optimal f, which is the optiomal bet size derived from the Kelly criterion.


Example: Betting full Kelly with a target of quadrupling the account

Initial bank roll 100,000
Ruin : a = 0.25 (when the account has dropped to 25,000)
Success: b = 4 (when the account has reached 400,000)
Kelly Factor: k = 1 (known as full Kelly betting)

You can then calculate the probability that you reach the target size of the account prior to ruin. This probability only depends from a, b and k, but not from the expecation or the standard deviations of the bets.

The formula is
Please register on futures.io to view futures trading content such as post attachment(s), image(s), and screenshot(s).


In the above case we would get P(0.25,4,1) = 80%.

The risk of ruin is the complementary probability and would accordingly show as 20%. This shows that betting full Kelly is quite risky.


Betting Half-Kelly

If you bet half Kelly, but leave the other parameters unchanged, you will get

P(0.25, 4, 0.5) = 98.5 %

The risk of ruin drops to 1.5 % (half Kelly) compared to 20% (full Kelly)!
Please register on futures.io to view futures trading content such as post attachment(s), image(s), and screenshot(s).


This may explain why many professional gamblers rather bet half-Kelly than full-Kelly.


Tip
Provided you use a fixed fractional betting system and adjust your bet size according to the Kelly Formula, the risk of ruin does not depend on the expectancy, as the Kelly criterion already adjusts the bet size to match expectancy. The risk of ruin only depends on a, b and k, where

a: fraction of initial account size considered as ruin
b: multiple of initial account size used as target
k: Kelly factor describing the bet size in terms of optimal f


@ThatManFromTexas:

I am counting on you to check the formula.


Last edited by Fat Tails; March 8th, 2012 at 02:51 AM.
Reply With Quote
The following 15 users say Thank You to Fat Tails for this post:
 
  #33 (permalink)
Elite Member
Houston,Tx
 
Futures Experience: Advanced
Platform: NinjaTrader
Broker/Data: Mirus Futures/Zen-Fire
Favorite Futures: TF
 
ThatManFromTexas's Avatar
 
Posts: 2,302 since Feb 2010
Thanks: 1,208 given, 4,283 received



Fat Tails View Post
@ThatManFromTexas:

I am counting on you to check the formula.

@Fat Tails

The ability to do math decreases exponentially inversely proportionally to an increase in aging .... it's gotten so bad... I don't even ask the strippers for change back... anymore....

I'm just a simple man trading a simple plan.

My daddy always said, "Every day above ground is a good day!"
Reply With Quote
The following user says Thank You to ThatManFromTexas for this post:
 
  #34 (permalink)
Membership Revoked
DetroitMIUSA
 
Futures Experience: Intermediate
Platform: NinjaTrader
Favorite Futures: ES
 
Posts: 193 since Feb 2012
Thanks: 26 given, 58 received

The strippers should be to do the math in their head for your change. I mean they ARE "going to college" AHHH aren't they?? LMAO

Reply With Quote
The following user says Thank You to PowerBroker for this post:
 
  #35 (permalink)
Site Administrator
Manta, Ecuador
 
Futures Experience: Advanced
Platform: My own custom solution
Favorite Futures: E-mini ES S&P 500
 
Big Mike's Avatar
 
Posts: 46,010 since Jun 2009
Thanks: 29,168 given, 82,186 received


Fat Tails View Post
(4) Bet size: The bet size has the largest impact on the risk of ruin. I will express the betsize as a multiple of optimal f, which is the optiomal bet size derived from the Kelly criterion.

Please help me understand where the bet size is determined in this example. Can you list an actual trade example (ie: entry, stop, target measured in terms of % risk or Kelly bet size)?

Thanks so much for contributing.

Mike

Due to time constraints, please do not PM me if your question can be resolved or answered on the forum.

Need help?
1) Stop changing things. No new indicators, charts, or methods. Be consistent with what is in front of you first.
2) Start a journal and post to it daily with the trades you made to show your strengths and weaknesses.
3) Set goals for yourself to reach daily. Make them about how you trade, not how much money you make.
4) Accept responsibility for your actions. Stop looking elsewhere to explain away poor performance.
5) Where to start as a trader? Watch this webinar and read this thread for hundreds of questions and answers.
6)
Help using the forum? Watch this video to learn general tips on using the site.

If you want
to support our community, become an Elite Member.

Reply With Quote
The following user says Thank You to Big Mike for this post:
 
  #36 (permalink)
Elite Member
Northern Germany
 
Futures Experience: Intermediate
Platform: NT
Favorite Futures: FDAX, CL
 
vvhg's Avatar
 
Posts: 1,583 since Mar 2011
Thanks: 1,016 given, 2,801 received


Fat Tails View Post
The formula is P(a,b.k) = ( 1 – a 1-2/k) / (b 1-2/k – a 1-2/k)

In the above case we would get P(0.25,4,1) = 80%.

The risk of ruin is the complementary probability and would accordingly show as 20%. This shows that betting full Kelly is quite risky.


Betting Half-Kelly

If you bet half Kelly, but leave the other parameters unchanged, you will get

P(0.25, 4, 0.5) = 98.5 %

The risk of ruin drops to 1.5 % (half Kelly) compared to 20% (full Kelly)!
Please register on futures.io to view futures trading content such as post attachment(s), image(s), and screenshot(s).


This may explain why many professional gamblers rather bet half-Kelly than full-Kelly.

@ThatManFromTexas:

I am counting on you to check the formula.


As @ThatManFromTexas is aging exponentially (as he stated) I quickly ran a few calculations.
I believe you missed a few brackets, so the formula should read:
P(a,b.k) = ( 1 – a (1-2/k)) / (b (1-2/k )– a (1-2/k))
Please correct me if I'm wrong!

An other strange thing i noticed is that if you bet very small like k/100 or so, the formula states a very high risk of ruin and although it would take long to reach b, I doubt that high a risk of ruin. I got P(0.25,4,0.01)=0.0653

Vvhg

Hic Rhodos, hic salta.
Reply With Quote
The following 3 users say Thank You to vvhg for this post:
 
  #37 (permalink)
Elite Member
Berlin, Europe
 
Futures Experience: Advanced
Platform: NinjaTrader, MultiCharts
Broker/Data: Interactive Brokers
Favorite Futures: Keyboard
 
Fat Tails's Avatar
 
Posts: 9,598 since Mar 2010
Thanks: 4,222 given, 25,354 received
Forum Reputation: Legendary


vvhg View Post
As @ThatManFromTexas is aging exponentially (as he stated) I quickly ran a few calculations.
I believe you missed a few brackets, so the formula should read:
P(a,b.k) = ( 1 – a (1-2/k)) / (b (1-2/k )– a (1-2/k))
Please correct me if I'm wrong!

An other strange thing i noticed is that if you bet very small like k/100 or so, the formula states a very high risk of ruin and although it would take long to reach b, I doubt that high a risk of ruin. I got P(0.25,4,0.01)=0.0653

Vvhg

@vvhg: Thank you for pointing this out. I did not omit any brackets, but had a problem with the editor of the forum software. It is not a WYSIWYG editor, everything was shown correctly until I saved it...

I have now replaced the formula with a picture file to avoid further confusion. Here it is:

Please register on futures.io to view futures trading content such as post attachment(s), image(s), and screenshot(s).

Reply With Quote
The following 3 users say Thank You to Fat Tails for this post:
 
  #38 (permalink)
Elite Member
Berlin, Europe
 
Futures Experience: Advanced
Platform: NinjaTrader, MultiCharts
Broker/Data: Interactive Brokers
Favorite Futures: Keyboard
 
Fat Tails's Avatar
 
Posts: 9,598 since Mar 2010
Thanks: 4,222 given, 25,354 received
Forum Reputation: Legendary


Big Mike View Post
Please help me understand where the bet size is determined in this example. Can you list an actual trade example (ie: entry, stop, target measured in terms of % risk or Kelly bet size)?

Thanks so much for contributing.

Mike

I will respond to this question and produce an example, which shows how to calculate the risk of ruin for a series of trades.

But before doing this, I want to come back to the definition of risk of ruin.

Let us assume that you start with a bank roll of $ 100,000.
Ruin: The account drops to less than $ 25,000 (preventing you from placing anymore intraday trades)
Target: You have quadrupled your account to $ 400,000.


Definition of Risk of Ruin


You cannot calculate the Risk of Ruin, without defining ruin and setting a target to achieve. Once this is defined, you can calculate the probability that you will experience a drawdown to ruin (account value of less than $ 25,000) prior to having achieved your target of $ 400,000. This probability is the Risk of Ruin.


Probability of Success of Your Trading Concept

This really like creating a small enterprise. You have a concept and an edge, which translates into a positive expectancy for your trades.

Step 1: Fix the size of your initial account, your pain threshold (where you stop trading), and your target.

Step 2: Calculate the Kelly bet size from your expectancy by using the concept of opimal f. Make sure to include commissions and other trading cost, when calculating the expectancy

Step 3: Adjust the Kelly bet size according to your risk appetite. Can you live with a risk of ruin of 20%? Then you are a full-Kelly trader. Do you tolerate something like a risk of ruin of 2%? Then you are a half-Kelly trader.

The theoretical probability that the endeavour succeeds is 98% for a risk of ruin of 2%. But is this realistic?


Be aware that not all risk is accounted for

Whether this approach is practical, can be debated. There is more risk involved than can be calculated via a Kelly formula. Your computer or the exchange may burn. Your edge may have prove to be a temporary edge at best, which is later annihilated by a change in the way markets operate. You may suffer from mental or physical illness, etc.

The calculated risk of ruin, should therefore be considered as minimum risk you are willing to accept. Nevertheless this approach allows to find an appropriate bet size in line with risk appetite.

Compounding returns is the single most important criterion, provided that there is an edge and that the psychological implications of being a trader have been mastered.

I will come back with a specific example for trading YM with that account of $ 100,000.


Last edited by Fat Tails; March 8th, 2012 at 03:54 AM.
Reply With Quote
The following 15 users say Thank You to Fat Tails for this post:
 
  #39 (permalink)
Elite Member
Ingatestone
 
Futures Experience: Intermediate
Platform: NinjaTrader
Favorite Futures: ES
 
Posts: 133 since Feb 2012
Thanks: 21 given, 54 received

Woefully Rusty at Programming.

Fat Tails, really good stuff.

Probably obvious, but think we should put it on paper. This all depends on independence of trades as Kelly does.

As I read it, the formula won't work for all possibilities. For (a stupid) example, wins 100 times losses, 90% win rate. You get an optimal f of 89.9%. Let a = 0.9, b = 1.1. Formula gives a 55% risk of ruin for optimal F, when anyone can tell you it should be 10% (as it would be for half kelly). I know this is a silly example, I just want to make sure I'm following correctly.

Secondly, I have written a small program to run account simulations. There are probably much better about, but I at least know what my code (supposedly) does. I'm really suspicious of the RNG funtion I'm using (I'm also very rusty), so don't trust it, maybe it will provide a base for someone to improve on. Plugged in some values of a system I have, namely:

p=82%
odds=0.5 (wins half the size of losses)

This gives us a Kelly of 46%.

Using a=0.25 and b=4, I got at 12.1% risk of ruin for full Kelly, and a 0.3% risk of ruin for half Kelly. This seems a bit out compared to your formula, but again, the RNG may be dodgy. It's probably my code, I'm sure I didn't have problems with RNGs before.

P.S. I know the coding is awful.
P.P.S. I have a terrible feeling I'm going to look a complete fool in a few short hours

Dovie'andi se tovya sagain.
Attached Files
Register to download File Type: txt RoR Model 1.0.txt (1.3 KB, 40 views)
Reply With Quote
The following 5 users say Thank You to Hotch for this post:
 
  #40 (permalink)
Elite Member
australia
 
Futures Experience: Beginner
Platform: NinjaTrader
Favorite Futures: -
 
Posts: 300 since Sep 2010
Thanks: 123 given, 136 received


Great stuffs guys.

I am becoming more and more convinced each day, the true edge in trading is not about finding the right indicators or even the best setups but in managing probability and R/R.

Reply With Quote
The following 5 users say Thank You to jonc for this post:

Reply



futures io > > > Risk of Ruin

Thread Tools Search this Thread
Search this Thread:

Advanced Search



Upcoming Webinars and Events (4:30PM ET unless noted)

July Journal Challenge w/$1100 in prizes from TopstepTrader

July
 

An Afternoon with FIO member Softsoap

Elite only

Battlestations: Show us your trading desks and win $750 in prizes

August
 

Extended Ask Me Anything w/Brett Steenbarger

Elite only

Prototyping Python Strategies (part 3) w/Ran Aroussi

Elite only

Brannigan Barrett w/Axia Futures

Elite only

Introduction to Phillip Capital futures brokerage services

Aug TBD

How Monte Carlo Analysis Can Help Your Trading w/Kevin Davey

Elite only
     

Similar Threads
Thread Thread Starter Forum Replies Last Post
More Contracts = Less Risk hondo69 Psychology and Money Management 27 October 25th, 2014 11:07 AM
Risk/Reward Calculator baruchs NinjaTrader 5 December 10th, 2013 05:56 AM
Even the Fed Can’t Value Financials’ Risk Quick Summary News and Current Events 0 November 14th, 2011 03:30 PM
ZN low risk JTrain Bonds and Interest Rates Trading 9 January 11th, 2011 05:11 PM
Effective risk sefstrat Psychology and Money Management 5 October 17th, 2009 11:37 AM


All times are GMT -4. The time now is 04:40 PM.

Copyright © 2017 by futures io, s.a., Av Ricardo J. Alfaro, Century Tower, Panama, +507 833-9432, info@futures.io
All information is for educational use only and is not investment advice.
There is a substantial risk of loss in trading commodity futures, stocks, options and foreign exchange products. Past performance is not indicative of future results.
no new posts
Page generated 2017-07-24 in 0.16 seconds with 20 queries on phoenix via your IP 54.156.65.91