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Risk of Ruin


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Risk of Ruin

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  #1 (permalink)
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I'd like to start a discussion on Risk of Ruin. The general concept of a Risk of Ruin analysis is to determine if you will go bust over a statistical number of trades. For example you may have a probability edge of 65% but after factoring commissions, slippage, and the risk of a consecutive losses, you may still blow up/ruin your account.

As most of you know, I am quite bad at math, which makes such analysis a big challenge for me. This is unfortunate, because a lot of what I want to do with my trading these days is based on math. So I could use some help.

Perry Kaufman's books:

Amazon.com: Smarter Trading: Improving Performance in Changing Markets (9780070340022): Perry Kaufman: Books

https://www.amazon.com/exec/obidos/ASIN/047126847X/

Kaufman gives us the following formula for calculating the risk of ruin:
risk_of_ruin = ((1 - Edge)/(1 + Edge)) ^ Capital_Units
Edge is the probability of a win.



There are a few different formulas floating around, and I've seen some requests to incorporate

I also noticed @Chris Capre has a blog post about this, which I found as I was doing some research:
Money Management and the Risk of Ruin | 2nd Skies Forex

So maybe he can join in the discussion. I've already asked him to come back early next year for another webinar based on risk management.

Also here is a link to Read The Prospectus on Monte Carlo simulation and a few images from his Excel Monte Carlo simulator (attached):
Monte Carlo Trade System Simulator Read the Prospectus







I would love it if one of you whiz-bang math guys could make an Excel spreadsheet or something similar to calculate and graph a risk of ruin analysis, with the output containing a schedule/list of trades and the resulting account balance. So we can see an entire list of trades and how things unfold.

Mike

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Risk of Ruin-magdon_max_drawdown.pdf  
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BM, as always you prove your talet of raising very interesting topics!
Things like RoR are often overlooked but in my view they are absolutely crucial! It's not only about trading well, it's trading well in a way that fits your account size as well as risk tolerance. And that means some number crunching...

I incorporated the more complicated version (I chose that one as the other seems to be way ovesimplified) into the journal template oveview, getting the numbers from actual trades. I will also incorporate a simple risk of ruin calculator.
Both should be available in the next update which will be coing real soon.


vvhg

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BM, have you got some more info on the complicated formula? I'm getting funny results with that one and I suspect that I interpret something wrong (putting in a wrong value) as the calculation itself sems to be right.

vvhg

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After spending quite some time trying to get that clculation to work, I finally ran out of ideas. I double and triple checked everything and think that I finally got it working as intended according to some more deailed explanations on the web...
But stillI have got two basic problems with the formula of Peter A. Griffin:
1. I found what seems to be differen versions of this formula
2. I tested the calculaions with different sets of trades and account sizes, the results are all obviously way off of rality...

I will post some calculations if you wish.


vvhg

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vvhg View Post
BM, have you got some more info on the complicated formula? I'm getting funny results with that one and I suspect that I interpret something wrong (putting in a wrong value) as the calculation itself sems to be right.

vvhg

I think there are a few interpretations floating around.

Here are some more links after a google search:

Risk Calculator

Risk of Ruin and Drawdown Calculation Tool | Au.Tra.Sy blog - Automated trading System

Confidence interval - Wikipedia, the free encyclopedia

Gambler's ruin - Wikipedia, the free encyclopedia

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vvhg View Post
After spending quite some time trying to get that clculation to work, I finally ran out of ideas.
.
.
.
I will post some calculations if you wish.

Yes, please share. It is at least a starting point. Then we just need some more math guys to comment and help out.

Mike

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Ok, here are my calculations. They are on overview tab to the right.

The middle version didn't work at all until I multiplied R by -1 but it still makes no sense.

Just play around with the trades a bit to see that the RoR calcs are off ( compared to the Monte carlo simulation as well as to common sense).

vvhg

Hic Rhodos, hic salta.
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Since this is a topic of extreme interest to me and my math is worse than yours BM, I am interested to see how this thread goes.

For those of you with more experience than me, I'd like to know if the RoR is removed IF a drawn down strategy is employed.

Say for instance you start with 50K and you have a max monthly stop of 8% of your capital and over the course of the month, you lose that much and so you stop until the next month begins. Month 2 has a max drawn down of 6% of remaining capital and for whatever reason, you hit this stop loss and once again you stop trading until month three begins. This month begins with a 4% max draw down of remaining capital and again, you stop trading once this level is hit, month four begins with a 2% max drawn down limit and of course, this too is hit and you stop trading until month five begins with a 1% max drawn down of remaining capital. End of month comes and the draw down is hit and you begin month 6 with a .5% draw down of remaining capital stop loss. Assuming month six is a bust and I would assume at this point if you are in a five month losing streak you will lose in month six as well, then at this point, by my calculations, about 75% of the original capital is left.

This all assumes that you stop trading at those levels of course but from a pure math standpoint, would someone be willing to put a spread sheet together that can approximate this scenario and see how it looks in black and white?

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PandaWarrior View Post
For those of you with more experience than me, I'd like to know if the RoR is removed IF a drawn down strategy is employed.

Theoretically, yes, practically not really.
What you described is (close to) a classic depreciation, always substract a fixed percentage of the current account vaue. As you only ever substract a fraction and never all of it, you will never hit zero. In practice this is a bit different as you coud very well describe bringing a $5000 account to $0.0001 as ruin.

I have attached a very simple spreadshet that calculates this and plots a graph.

vvhg

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