Lecture six, we're halfway there, guys. So how did you do on the test? It's interesting because the probability of Ruin is a concept that most traders are completely unaware of. The matrix that I will show you shortly will enable you to assess your trading system. What the probability of Ruin is telling you is the likelihood of losing all your trading capital to the point that it cannot be recovered. and ruin is defined as a 50% reduction in your capital.
So, Put simply, it's saying what is the likelihood that my trading account will have over time if I use this trading system and trade at this size portrayed? Before we look at the matrix Let's just look at a couple of definitions. And I'm sure you're all familiar with wind percentage. And that's really the fraction of wins compared to the total number of trades or matches played. So say for example, you took five trades, and one two of them, your win percentage will be two fifths, or 40%. The risk reward ratio is simply says, How much do I expect to gain for every unit I risk.
For example, a two to one risk reward ratio would mean that for every dollar risked, the trader would expect to make $2 in return. So let's move to the matrix. Since we've covered probabilities, you will now appreciate why having an accurate win percentage is key. Because if your sample is too small, you could lose all your money when you actually thought you had a profitable within trading system. Furthermore, if you trade too big, you will also wipe out due to the probability of ruin. So, for any trading system, this matrix will tell you the likelihood that over time, you will deplete your trading account by 50%.
If you only risk 1% of your trade capital, this is extremely powerful, yet it is hardly known by amateur traders. The sweet spot is actually a 42% win percentage and a risk reward of two to one. And I know that if you do the maths, this will still yield a profit. But as we now know, because we understand probabilities, we could get all our losing trades up front and in a row. So whilst it does actually mathematically yield a slight profit, it could actually break even. However, if your trading system can achieve better To them, then a 42% win percentage and a two to one risk reward ratio, then you will be successful over time.
In the next lecture, we begin to look at trading psychology and what this means for you as a professional trader