I was not sure if this is an advanced topic, but since nobody has been able to answer me earlier I take my chances
I found the following table in one of my books on finance and trading. The author does not mention where he got it and I do not believe he has made it himself. Still, I can`t find much info about it on the internet. Here goes:
Profit/Loss Ratio - P/R
Winning Percentage - % Win
Please see the table below
[html] % winner
P/R 30% 40% 50% 60%
1:1 99 88 50 12
2:1 74 14 2 0
3:1 23 5 1 0
4:1 14 5 1 0
* Ruin is defined as a 50% drawdown from starting equity
* The matrix assumes 100 trades executed for the same reason.
I understand the table this way:
Let`s say we have 40% winners/60% losers and a profit/loss ratio of 2:1. This gives us a 14% probability of ruin. That is, a 14% probability that all the 60 losing trades come successively.
Could anyone please explain to me how this is calculated?
I am making a sheet in excel where I want to experiment with different variables (initial account size in trading account, average size of winners/losers, different profit/loss ratios) and see how it affects the probability of ruin.
Obviously, if the matrix above were to account for different account sizes, the average loser (in dollar) had to be adjusted so that the size of the total loss amounted to a 50% drawdown after 60 trades.
If we have a $5000 account, drawdown would occur if we had 60 losers in a row with an average loss of $41.67.
With a $10,000 account, this would only lead to a drawdown of 25%. Thus, the average loss would have to be increased to $83.33 if we were to use the matrix.
Also, I`m not sure if I understand how in the matrix the different profit/loss ratios affect the probability of ruin, since the loss is constant (1 dollar for example).
I hope someone is able to follow my thoughts
My understanding of probabilities is very weak and I`m not sure if I`m even communicating correctly what I want to know.
Thanks very much in advance to anyone who has some clues or help to provide.