Risk Management Terms

Asymmetric risk means the potential upside on a trade outweighs the downside, creating favorable risk/reward ratios.

Capital preservation focuses on protecting trading funds with conservative sizing, strict stops, and disciplined process.

Counterparty risk is the chance that the party on the other side of a trade fails to honor its obligations, such as a broker default.

Diversification reduces risk by spreading exposure across multiple pairs, strategies, or timeframes.

Drawdown is the peak-to-trough decline in your account value, expressed as a percentage. For example, if your account drops from $10,000 to $8,000, that's a 20% drawdown. Large drawdowns require exponentially larger gains to recover.

Free Margin is the amount of money in your trading account available to open new positions. It's calculated as Equity minus Used Margin. When free margin drops too low, you risk a margin call - always maintain at least 30% of your balance as free margin buffer.

The Kelly Criterion is a position-sizing formula that allocates capital based on edge and payoff ratio, guiding how much equity to risk per trade for maximum long-term growth when inputs are accurate.

A margin call is a warning that your equity has fallen below required margin level (typically 100%). If your account continues losing and hits the stop-out level (typically 50%), your broker automatically closes positions. Margin calls signal dangerous account risk.

Margin level is the ratio of equity to used margin expressed as a percentage: (Equity / Used Margin) × 100%. It measures account health - above 200% is safe, below 100% triggers margin call, below 50% causes stop-out.

Max drawdown captures the largest peak-to-trough equity decline for a strategy, defining worst-case pain and the capital cushion you need to survive it.

Negative balance protection ensures traders cannot owe a broker more than their deposits, resetting balances to zero after extreme events.

Position sizing is calculating how many lots to trade based on your account size, risk tolerance, and stop loss distance. Professional traders use the formula: Lot Size = (Account × Risk%) / (Stop Loss Pips × Pip Value) to never risk more than 1-2% per trade.

Recovery factor divides net profit by maximum drawdown, revealing how efficiently a system rebounds after losses and how productively it uses risk capital.

Risk management is the process of identifying, analyzing, and mitigating uncertainty in trading decisions through strategies like stop-losses, position sizing, and leverage control to preserve capital.

Risk of ruin measures the probability that a trader loses so much capital they can no longer participate, a value driven by win rate, payoff ratio, and the percentage of equity risked per trade.

Risk/Reward Ratio (R:R) compares your potential profit to potential loss on a trade. A 2:1 R:R means you risk $100 to potentially make $200. Professional traders aim for minimum 2:1 ratios, which allows profitability even with 50% or lower win rates.

The Sharpe ratio measures risk-adjusted returns by dividing excess performance by volatility, helping compare trading strategies.

Slippage is the difference between your expected execution price and actual fill price. It occurs during high volatility, low liquidity, or news events when prices move faster than orders can be filled. Slippage can work for or against you.

Slippage tolerance is the maximum deviation from your requested price that you are willing to accept on execution, protecting you from fills far worse than expected.

The Sortino ratio measures returns relative to downside deviation only, rewarding strategies that deliver gains while minimizing harmful drawdowns.

A stop loss is an automatic order that closes your trade at a predetermined price level to limit losses. It's the most important risk management tool - professional traders always use stop losses and typically risk only 1-2% of their account per trade.

A stop loss automatically closes your trade at a predetermined price to limit losses. It is the most important risk management tool in forex trading.

A stop out is the broker’s forced liquidation when margin level falls below its threshold, closing positions to keep the account from going negative.

Tail risk encompasses the low-probability, high-impact events—such as shock policy moves or flash crashes—that can gap markets far beyond normal volatility and overwhelm stop-loss protection.

A trailing stop is a dynamic stop-loss that moves with favorable price movement, locking in profits while giving trades room to run. It trails behind price by a set distance (e.g., 50 pips), never moving backward, triggering if price reverses by that amount.