DEFINITION of 'Risk Of Ruin'
The probability of an individual losing sufficient trading or gambling money (known as capital base) to the point at which continuing on is no longer considered an option to recover losses.
Risk of ruin is calculated by taking into account the probability of winning (or making money on a trade), the probability of incurring losses, and the portion of an individual's capital base that is in play or at risk. Also known as the "probability of ruin".
BREAKING DOWN 'Risk Of Ruin'
Risk of ruin need not result in bankruptcy (although it often does), but rather the point at which continuing on would be unwise. It signifies a risk more relevant in trading and gambling, where there is a high probability of losing an entire bet or trade.
The risk becomes even greater for individuals who trade large percentages of their accounts. For example, say an investor has $3,000 and purchases $3,000 worth of call options. If there is a 40% chance that the options will not be exercised, then the risk of ruin is 40%.