Losing Streaks and the Risk of Ruin

One strategy, hundreds of kinds of luck

A backtest gives you one historical curve, but the order of future wins and losses is random. Monte Carlo simulation runs the same strategy hundreds or thousands of times to show you the possible good and bad outcomes.

Risk of ruin isn't linear

Double the risk per trade and the risk of ruin more than doubles. Even a strategy with positive expectancy can be wiped out by betting too big before its good luck shows up.

Write a drawdown plan in advance

The typical maximum drawdown in the simulation is the “normal pain”. Write down in advance: at what drawdown you'll halve position size, pause and review. When emotions are at their worst, follow the rules, not your gut.

Key takeaways

• Even with positive expectancy, you can lose many trades in a row in the short run. That's probability, not a broken strategy.
• As risk per trade rises, the risk of ruin climbs much faster than intuition suggests. A nice median outcome doesn't mean most paths are safe.
• Use simulations to estimate a typical maximum drawdown, and write down in advance the drawdown at which you'll cut size and review.
• With negative expectancy, smaller positions only make the losses arrive more slowly; they can't save you.

Try it yourself

You can do these exercises in this lesson's interactive simulation:

1. Keep the defaults (45% win rate, 1.5 payoff ratio, 2% risk): what's the median outcome as a multiple? What multiple does the explanation card give for the worst 10%?
2. Look at “Typical maximum drawdown”: roughly what is it by default? What does it become after lowering the risk to 1%?
3. Raise the risk per trade to 10%: the median outcome went up, but what's the chance of falling below 50%?
4. Set the risk back to 2% and lower the win rate to 35%: what's the expectancy? Then lower the risk to 0.5%: what's the chance of ending up with a loss now?

Quiz and explanations

1. For a strategy with a 50% win rate, a streak of 6 losses over long-term trading is…

Answer: Bound to happen sooner or later.After a few hundred trades, a 6-loss streak is very common.

2. If you raise risk per trade from 1% to 10%, the risk of ruin will…

Answer: Rise sharply.The bigger the risk, the fewer losses it takes to knock the account somewhere it can't recover from.

3. With a 50% win rate, roughly what's the probability that a particular run of 5 trades are all losers?

Answer: About 3%.0.5⁵ = 1/32 ≈ 3.1%. It looks small on its own, but over a few hundred trades, a streak like this is almost certain to show up.

Terms in this lesson

• maximum drawdown (Max Drawdown): The biggest drop from an equity peak to the lowest point that follows.
• Monte Carlo simulation (Monte Carlo Simulation): Using random numbers to replay the same strategy hundreds or thousands of times, revealing the spread of possible outcomes instead of a single historical curve.
• risk of ruin (Risk of Ruin): The chance your account falls too low to keep trading (or below a set floor); it climbs quickly as risk per trade grows.
• risk per trade (Risk per Trade): How much you're willing to lose if a trade hits its stop-loss, usually 0.5%–2% of the account.
• risk/reward ratio (Risk : Reward): Money you could lose : money you could make; 1:2 means risking $1 to aim for $2.
• win rate (Win Rate): The share of all trades that made money.