Risk Management

• Stop LossBeginner11 min read

  A stop loss is an exit you set in advance — usually an order — that closes a losing trade automatically once the price reaches a level you chose.

• LeverageIntermediate9 min read

  Leverage means controlling a position larger than your own money — through borrowing or a contract that needs only a deposit — so that gains and losses are both multiplied.

• MarginIntermediate9 min read

  Margin is the money you put up as collateral so that a broker lends you funds, or an exchange lets you hold a position larger than your cash.

• LiquidationIntermediate8 min read

  Liquidation is the forced closing of a leveraged position by a broker or exchange when your collateral no longer covers the required margin.

• Position SizingBeginner8 min read

  Position sizing is deciding how many shares, contracts or coins to trade so that, if your stop is hit, you lose only an amount you chose in advance.

• Risk-to-Reward RatioBeginner7 min read

  The risk-to-reward ratio compares how much you could lose on a trade, down to your stop, with how much you aim to gain, up to your target.

• Take ProfitBeginner7 min read

  A take profit is a pre-set exit — usually a limit order — that closes a winning trade automatically once the price reaches your target.

• DrawdownIntermediate6 min read

  Drawdown is how far an account or investment has fallen from its previous peak, usually expressed as a percentage.

• Risk per TradeBeginner5 min read

  Risk per trade is the amount you accept losing if a trade hits its stop, often set as a small fixed percentage of the account such as 1%.

• R-MultipleIntermediate4 min read

  An R-multiple expresses a trade's result in units of its initial risk: if you risked $100 and made $250, the trade returned 2.5R.

• Risk of RuinAdvanced5 min read

  Risk of ruin is the probability that losses shrink an account to a point where you can no longer trade your plan; it rises quickly with larger risk per trade.

• CorrelationIntermediate4 min read

  Correlation measures how closely two prices move together, from +1 (always together) to −1 (always opposite); highly correlated positions add up to one bigger bet.

• DiversificationBeginner4 min read

  Diversification is spreading money across assets that do not all move together, so that a loss in one holding has a smaller effect on the whole portfolio.

• Daily and Weekly Loss LimitsBeginner4 min read

  A loss limit is a pre-set amount of loss after which you stop trading — for the rest of the day or week. It caps the damage from bad days and from emotional decisions after losses. Many prop-firm and funded accounts enforce them.

• Scaling In and OutIntermediate4 min read

  Scaling in is building a position in several planned stages; scaling out is closing it in stages, for example taking partial profit at a first target and leaving a “runner” for a bigger move.

• Trade ManagementIntermediate4 min read

  Trade management is everything you decide after entering: moving or trailing the stop, taking partial profits, adding to the position or closing early. Rules decided in advance work better than decisions made in the moment.

• ExposureIntermediate3 min read

  Exposure is how much of your money is affected by a change in a price: a $10,000 position has $10,000 of exposure even if you used only $1,000 of margin.

• Value at RiskAdvanced4 min read

  Value at risk estimates a loss threshold for a given period and confidence level: a one-day 95% VaR of $10,000 means losses should exceed $10,000 on only about 5% of days, if the model is right. Conditional VaR (expected shortfall) is the average loss on those worst days.

• BetaAdvanced4 min read

  Beta measures how much an asset tends to move relative to a benchmark: a beta of 1.5 has historically meant moving about 1.5 times as much as the market.

• Counterparty RiskIntermediate4 min read

  Counterparty risk is the danger that the other side of a deal — a broker, exchange or trading partner — fails to meet its obligations, for example by becoming insolvent.

• Margin CallIntermediate4 min read

  A margin call is a demand from your broker to add money or reduce positions because your account equity has fallen below the required margin.

• Risk ManagementBeginner4 min read

  Risk management is the set of rules that limits how much you can lose — through position size, stop losses, leverage limits and diversification — so that no single mistake ends your trading.

• Cross and Isolated MarginAdvanced4 min read

  With isolated margin, only the collateral assigned to a position can be lost if it is liquidated; with cross margin, all available funds in the account support every open position.

• Account EquityIntermediate3 min read

  Account equity is your balance plus or minus the unrealized result of open positions — what the account would be worth if everything were closed now.

• Gap RiskIntermediate4 min read

  Gap risk is the danger that the price jumps past your stop level — for example overnight or after news — so the order fills at a much worse price than planned.

• Averaging Down and Averaging UpIntermediate3 min read

  Averaging down is buying more of a position that has fallen, which lowers the average entry price but increases exposure to a trade that is already going wrong. Averaging up is buying more as the price rises.

• Black SwanIntermediate3 min read

  A black swan is a rare, hard-to-predict event with extreme market consequences that people often rationalise only after it has happened.

• Trading CapitalBeginner3 min read

  Trading capital is the money set aside for trading — ideally money whose loss would not affect your essential finances.

• CollateralIntermediate3 min read

  Collateral is money or assets pledged to secure a loan or a leveraged position; the lender can take or sell it if you cannot cover losses.

• Concentration RiskIntermediate3 min read

  Concentration risk is the danger of having too much money in one asset, or in assets that tend to fall together, such as several tech stocks.

• Drawdown DurationIntermediate3 min read

  Drawdown duration — or time under water — is how long an account stays below its previous peak before making a new high. A strategy can have a modest maximum drawdown but a very long recovery.

• Free MarginIntermediate3 min read

  Free margin is the part of your equity not tied up as margin for open positions, and therefore available for new trades or to absorb losses.

• Invalidation LevelBeginner3 min read

  The invalidation level is the price or condition at which your trade idea is clearly wrong. It is the natural place for a stop-loss.

• Kelly CriterionAdvanced4 min read

  The Kelly criterion is a formula for the fraction of capital to risk that maximises long-run growth, given a known win probability and payoff. For a bet with win probability p and payoff b to 1, the fraction is p − (1 − p) ÷ b. Because real edges are uncertain, many traders use a fraction of it (“fractional Kelly”).

• Margin LevelAdvanced3 min read

  Margin level is a ratio of your equity to the margin in use, typically equity ÷ used margin × 100%; platforms close positions when it falls below a set level.

• Net PositionIntermediate3 min read

  Your net position is what remains after offsetting longs against shorts in the same asset — long 10 and short 4 is a net long position of 6.

• Overnight Financing FeeIntermediate4 min read

  An overnight fee is the financing cost a broker charges for holding certain leveraged positions, such as CFDs or forex, past the daily cut-off time.

• Risk Parity, Minimum Variance and the Efficient FrontierAdvanced4 min read

  The efficient frontier is the set of portfolios offering the highest expected return for each level of risk, under a model’s assumptions. A minimum variance portfolio aims for the lowest possible volatility; risk parity allocates so each asset contributes equally to risk rather than equally in money.

• Portfolio HeatIntermediate3 min read

  Portfolio heat is the total amount you would lose if every open position hit its stop at once, usually as a percentage of the account. Five trades each risking 1% give 5% heat. Traders cap it to avoid large combined losses.

• Pre-Trade Risk Checks and Kill SwitchesAdvanced4 min read

  Pre-trade risk checks automatically block orders that break limits on size, price or exposure before they reach the market. A kill switch cancels all open orders and stops an automated system at once. Both are standard protections for algorithmic trading.

• PyramidingAdvanced3 min read

  Pyramiding is adding to a winning position as it moves in your favour, usually in smaller amounts each time and with the stop raised so the total risk stays controlled.

• Risk Budget and Risk ContributionAdvanced3 min read

  A risk budget is the amount of risk allocated to a portfolio, strategy or position. Risk contribution is how much of the portfolio’s total risk comes from each holding — which can differ greatly from its share of the money, because volatile, correlated holdings contribute more.

• RiskBeginner3 min read

  In trading, risk is the possibility of losing money — and, more precisely, how much you could lose and how likely that outcome is.

• Risk StackingIntermediate3 min read

  Risk stacking is holding several positions that all depend on the same underlying risk — for example, long three technology stocks and a Nasdaq index future. They will tend to lose together, so the real risk is larger than each position suggests.

• Stress Testing and Scenario AnalysisAdvanced3 min read

  Stress testing checks how a portfolio would fare under severe, hypothetical shocks, such as a 2008-style crash. Scenario analysis compares results under several possible futures; sensitivity analysis changes one input at a time to see which assumptions matter most.

• Volatility TargetingAdvanced3 min read

  Volatility targeting adjusts position size so that a portfolio’s expected volatility stays near a chosen level: exposure is cut when markets become volatile and raised when they calm down.

• AlphaIntermediate4 min read

  Alpha is the part of a return that beats what the market or a benchmark delivered for the same risk. Positive alpha suggests skill or an edge; Jensen's alpha measures it against the return the CAPM would predict from the portfolio's beta.

• Compound Annual Growth RateBeginner4 min read

  The compound annual growth rate is the steady yearly rate that would turn a starting value into an ending value: (end ÷ start) raised to 1/years, minus 1. Doubling $10,000 to $20,000 over 5 years is a CAGR of about 14.9%.

Each term is defined in one sentence. Terms marked “Article in preparation” will get a full step-by-step article.

• Basis Risk

  AdvancedGlossary

  Basis risk is the chance that a hedge does not move exactly opposite to what it protects, because the gap between the hedge's price and the exposure's price changes. A jet-fuel user hedging with crude oil futures carries it.

• Benchmark

  BeginnerArticle in preparation

  A benchmark is the yardstick a portfolio or strategy is judged against — often an index such as the S&P 500 for US stocks. Beating your benchmark after costs is what shows skill; a 10% gain is poor if the benchmark rose 20%.

• Currency Risk

  IntermediateArticle in preparation

  Currency risk is the chance that exchange-rate moves eat into returns from an asset priced in another currency. A US stock up 10% gives a euro investor less if the dollar fell 8% against the euro; hedged funds and FX forwards reduce the effect.

• Haircut

  IntermediateGlossary

  A haircut is a reduction applied to the value of an asset used as collateral. With a 20% haircut, $100 of bonds counts as only $80 of collateral, which protects the lender if the asset's price falls.

• Idiosyncratic Risk

  IntermediateGlossary

  Idiosyncratic risk is the risk specific to one company or asset — a failed product, a fraud, a lawsuit — rather than the market as a whole. Holding many unrelated positions largely diversifies it away; market risk cannot be removed that way.

• Inflation Hedge

  IntermediateGlossary

  An inflation hedge is an asset expected to hold its real value when prices rise — inflation-linked bonds most directly, and often commodities, real estate or gold. None works reliably every time; stocks and bonds both struggled in the 2022 inflation surge.

• Loan-to-Value RatioLTV

  IntermediateGlossary

  Loan-to-value compares the size of a loan with the value of the collateral behind it. A $6,000 crypto loan against $10,000 of bitcoin is 60% LTV; if bitcoin falls and LTV crosses the lender's limit, the collateral is sold.

• Negative Balance Protection

  BeginnerArticle in preparation

  If a weekend gap or flash move pushes a leveraged account below zero, negative balance protection means the broker absorbs the shortfall and you owe nothing more. EU and UK rules make it compulsory for retail CFD accounts; elsewhere it depends on the broker.

  Rules differ between countries; this is general information, not tax or legal advice.

• Normal Distribution

  IntermediateGlossary

  The normal distribution is the symmetric bell curve in which about 68% of outcomes fall within one standard deviation of the average and 95% within two. Many risk models assume returns are normal, but real markets have more extreme days.

• Omega Ratio

  AdvancedGlossary

  The Omega ratio compares probability-weighted gains above a chosen threshold return with probability-weighted losses below it. Because it uses the whole return distribution, it captures skew and fat tails that the Sharpe ratio misses.

• Portfolio Insurance

  AdvancedGlossary

  Portfolio insurance is a dynamic hedging strategy that sells index futures as prices fall to protect a minimum portfolio value. Its mass selling was blamed for deepening the October 1987 crash.

• Recovery Factor

  IntermediateGlossary

  The recovery factor divides a strategy's net profit by its maximum drawdown. A value of 3 means it made three times its worst peak-to-trough loss; higher values show the strategy earns back its drawdowns more convincingly.

• Rehypothecation

  AdvancedGlossary

  Rehypothecation is a broker or lender reusing collateral that clients pledged to it, for example lending it out to raise its own funding. It is limited for regulated US brokers, but unchecked reuse helped sink several crypto lenders in 2022.

• Return on InvestmentROI

  BeginnerArticle in preparation

  Return on investment measures profit as a percentage of the money put in: gain ÷ cost × 100. Buying for $1,000 and selling for $1,150 after $10 of fees is a 14% ROI. It ignores how long the money was tied up, so compare annualised figures for different holding periods.

• Risk Tolerance

  BeginnerArticle in preparation

  Risk tolerance is how much loss and volatility you can accept — both financially and emotionally — without abandoning your plan. Many people overestimate it until they live through a real drawdown.

• Skewness and Kurtosis

  AdvancedGlossary

  Skewness measures whether returns lean towards big gains or big losses; kurtosis measures how heavy the tails are. Market returns typically have fat tails — extreme days happen far more often than a normal distribution predicts.

• Standard Deviation

  IntermediateArticle in preparation

  Standard deviation measures how widely returns spread around their average, and is the most common measure of volatility. Daily figures are annualised by multiplying by the square root of the number of trading days, about 252.

• Stop Distance

  BeginnerArticle in preparation

  Stop distance is the gap between your entry and your stop-loss, in price, pips or percent. It sets your risk per unit: with $100 to risk and a $2 stop distance, you can buy 50 shares. Wider stops mean smaller positions for the same risk.

• Stop Out

  IntermediateArticle in preparation

  Brokers set a margin-level floor — 50% for EU retail CFD accounts — at which they start closing your positions without asking, usually the biggest loser first. It is the last line of defence after a margin call.

  The exact rules and formulas differ between brokers and exchanges — check your platform’s documentation.

• Systematic and Systemic Risk

  IntermediateArticle in preparation

  Systematic risk is market-wide risk that diversification cannot remove — what beta measures. Systemic risk is the danger that one failure spreads and brings down the financial system, as in 2008.

• Total Return

  BeginnerArticle in preparation

  Total return counts everything an investment earns: price change plus dividends or interest, usually assuming they are reinvested. Comparing total returns matters because a high-dividend stock can look flat on a price chart while still paying well.

• Treynor Ratio

  AdvancedGlossary

  The Treynor ratio divides a portfolio's return above the risk-free rate by its beta, so it measures reward per unit of market risk. Unlike the Sharpe ratio, it ignores risk that diversification could remove.

• Ulcer Index

  AdvancedGlossary

  The Ulcer Index, created by Peter Martin, measures downside risk from both the depth and the length of drawdowns: the square root of the average squared percentage drop from the latest high. Lower values mean a smoother ride.