GlossaryNever risk more than 1% of account equity on a single trade — the most widely-quoted retail money management rule.
The 1% rule caps the damage from any single losing trade at 1% of equity. At 1% risk per trade, you'd need 100 consecutive losers to wipe out — statistically near-impossible for any strategy with positive expectancy.
Also called:
1% rule, two-percent rule
Example
10-trade losing streak at 1% risk: equity goes from $10,000 to ~$9,044 — uncomfortable but survivable. Same streak at 5% risk: $10,000 to ~$5,987 — catastrophic.
A volatility measure — the average distance price travels per period, accounting for gaps.
ATR (Wilder, 1978) is the average of the 'true range' over N periods. True range captures gaps (it's the max of high-low, high-prev-close, low-prev-close) so ATR reflects real volatility, not just intraday swing.
Also called:
ATR
Example
EUR/USD daily ATR(14) is 60 pips. You want a stop that survives normal noise → place SL 1.5× ATR away from entry (≈90 pips).
Moving your stop-loss to the entry price once the trade is in profit — risk-free from that point on.
A break-even stop is a manual or automated move of your SL to entry price once price has moved a certain distance in your favour. Once moved, the worst case is zero (minus spread/commission).
Also called:
BE stop
Example
Buy at 1.0800, SL 1.0780 (20-pip risk). Price reaches 1.0820 (+20 pips = 1R). Move SL to 1.0800. Trade is now risk-free.
Watch out
Moving to BE too aggressively (e.g. after just a few pips) gets you stopped on noise. Wait for at least 1R of confirmation.
Reinvesting profits so the next period's return is earned on a larger base — the mechanism behind exponential equity curves.
Compounding is what turns a steady % return into outsized long-term wealth. At 2% per month compounded, $10,000 becomes $26,800 in 5 years; at simple 2% per month it's $22,000.
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Statistical measure (−1 to +1) of how two instruments move together. +1 = perfect lockstep, −1 = perfect opposites, 0 = independent.
Correlation matters for position sizing — running 3 long trades on positively-correlated pairs is effectively one big trade, not three independent ones.
Example
EUR/USD and GBP/USD typically run +0.7 to +0.9 daily correlation. AUD/USD vs USD/JPY often inversely correlated through risk-on/risk-off flow.
Spreading capital across uncorrelated positions to reduce overall portfolio risk.
Diversification works when positions are genuinely uncorrelated — long EUR/USD and long GBP/USD aren't diversified (both are short USD). True diversification spans asset classes, strategies, and timeframes.
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The decline from a peak in equity to a subsequent trough — measured in percent or dollars.
Drawdown measures how much your account has fallen from its highest balance. Every strategy has drawdowns; the question is how big, how long, and how often.
Also called:
DD
Example
Account peaks at $12,000, falls to $10,800, then recovers. Drawdown = (12,000 − 10,800) / 12,000 = 10%.
A chart of account balance over time — the single most informative view of strategy health.
A clean upward-sloping equity curve with shallow drawdowns is the gold standard. Wild swings, flat periods, and deep drawdowns are warnings even if the total return looks good.
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The average profit per trade, computed from win rate and average win/loss size.
Expectancy tells you what to expect from one average trade, in either dollars or R. Positive expectancy = profitable system over time; negative = you're paying to gamble.
Also called:
per-trade expectancy
Example
50% win rate, average win $200, average loss $100. Expectancy = (0.5 × 200) − (0.5 × 100) = +$50 per trade.
Holding offsetting positions to reduce risk — e.g. long EUR/USD and short EUR/GBP to neutralise EUR exposure.
True hedging uses correlated instruments to cancel out a specific risk (e.g. holding a USD asset and selling USD futures). Retail FX 'hedging' often means holding opposite positions in the same pair — which is mathematically a closed trade, just with double spread and swap cost.
Also called:
hedge
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A formula that calculates the bet size which maximises long-run growth given your edge and odds.
Kelly answers 'what fraction of bankroll should I bet?' For binary outcomes: f* = (bp − q) / b where b is net odds, p is win probability, q = 1 − p.
Also called:
Kelly
Example
60% win rate, 2:1 R:R. Kelly fraction = (2 × 0.60 − 0.40) / 2 = 40% of account per trade — far too aggressive in practice.
Watch out
Kelly assumes your win-rate estimate is exact. Even small over-estimation of edge leads to catastrophic over-betting.
The largest peak-to-trough equity decline seen in a strategy's history — a key risk metric.
Maximum drawdown (Max DD) is the worst drawdown observed. It's a critical comparison metric: a strategy with 30% return and 10% Max DD is far better than one with 30% return and 40% Max DD.
Also called:
max DD, MDD
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The process of choosing how many lots to trade based on your account size, stop distance, and risk per trade.
Position sizing is what turns a 'maybe' edge into a sustainable equity curve. Risk a fixed percent of equity (typically 0.5–2%) per trade and size each trade so the stop-loss equals that risk in dollars.
Also called:
sizing, money management
Example
Account $10,000, risk 1% = $100. Stop 25 pips on EUR/USD ($10/pip per lot). Lots = $100 / (25 × $10) = 0.4.
Total gross profits divided by total gross losses — a single number summary of strategy quality.
Profit factor (PF) of 1.0 = breakeven. 1.5 = decent. 2.0+ = strong. Anything above 3.0 in backtests is usually curve-fit unless the sample is huge.
Also called:
PF
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The probability that an account will lose enough to be unrecoverable, given a strategy's win rate and risk per trade.
Risk of ruin (RoR) collapses win rate, R:R, and bet size into a single probability of going broke. Even a system with positive expectancy can have meaningful RoR if you bet too big.
Also called:
RoR
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The maximum dollar (or percent) amount you allow yourself to lose on a single trade.
Risk per trade is set as a percent of account equity (commonly 0.5–2%) and combined with stop distance to derive position size. Keeping it constant in % terms means losses shrink with your account in drawdown and grow with your account in profit — automatic compounding.
Example
Account: $20,000. Risk per trade: 1% = $200. Trade with 40-pip stop on EUR/USD → lots = $200 / (40 × $10) = 0.5 lots.
The ratio of potential profit to potential loss on a trade — e.g. 2:1 means risking $1 to make $2.
Risk-reward ratio compares the distance from entry to stop-loss (risk) against the distance from entry to take-profit (reward). A 2:1 R:R lets you be profitable at a 40% win rate; a 1:1 needs 50%+; a 0.5:1 needs 67%+.
Also called:
R:R, RR, reward-to-risk
Example
Buy at 1.0800, SL 1.0780 (20-pip risk), TP 1.0850 (50-pip target). R:R = 50/20 = 2.5:1.
Watch out
A great R:R on paper means nothing if your stop is too tight to give the trade room. Anchor stops to structure first, then compute R:R; never the other way around.
A risk-adjusted return metric: excess return divided by standard deviation of returns.
Sharpe ratio (William Sharpe, 1966) measures how much return you got per unit of volatility. Higher is better. >1 is decent, >2 is excellent, >3 is exceptional (and usually too good to be true).
Also called:
Sharpe
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Like Sharpe but only penalises downside volatility — a better measure for asymmetric strategies.
Sortino fixes Sharpe's main weakness: it uses only the standard deviation of negative returns (downside deviation). Strategies that have big winners and small losers will look much better under Sortino than Sharpe.
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A pre-set order that closes a losing trade automatically at a maximum acceptable loss.
Stop Loss (SL) is the single most important risk-control tool in trading. It defines the worst case for a trade before you take it, and removes the emotional 'just one more pip' decision when price moves against you.
Also called:
SL, stop, protective stop
Example
Account: $10,000. Risk per trade: 1% ($100). Trade: buy EUR/USD with stop 25 pips away. Position size: $100 ÷ (25 pips × $10/pip per lot) = 0.4 lots.
Watch out
Setting stops based on dollar-amount only (e.g. '$50 max') leads to stops too close to obvious price levels — and frequent stop-outs on noise. Anchor stops to structure first, then size the position.
A pre-set limit order that closes a winning trade automatically when price reaches your target.
Take Profit (TP) automates the exit on winning trades. Set when you open the position, it sits as a limit order on the opposite side and executes the moment price touches your target.
Also called:
TP, profit target, target
Example
You buy EUR/USD at 1.0800 with a stop at 1.0780 (20-pip risk) and TP at 1.0840 (40-pip target). That's a 2:1 reward-to-risk plan.
A stop-loss that automatically follows price in your favour, locking in profit as the trade moves.
A trailing stop is a stop-loss order with a dynamic level. It moves with price in your favour but never moves against you. You define the trail distance (in pips, ticks, or %); the broker handles the rest.
Also called:
trailing SL
Example
You buy EUR/USD at 1.0850 with a 30-pip trailing stop. Price rises to 1.0900 → stop moves to 1.0870. Price hits 1.0920 → stop moves to 1.0890. Price reverses to 1.0890 → you're out at +40 pips.
Watch out
In MetaTrader, trailing stops are client-side: if your terminal disconnects, the stop stops updating. Use a VPS or server-side trailing if available.
An estimate of the worst expected loss over a given period at a given confidence level — e.g. '1-day 95% VaR = $500' means there's a 5% chance of losing more than $500 tomorrow.
VaR is the institutional standard for portfolio risk. It collapses many positions into one number. Major weakness: it ignores what happens in the worst 5% — black swans break VaR.
Also called:
VaR
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The degree of price variation in a given period — high volatility = big swings, low volatility = quiet markets.
Volatility is measured in absolute terms (pips, dollars) or relative (%, standard deviations). It expands and contracts in cycles — quiet periods often precede explosive moves and vice versa.
Example
EUR/USD daily ATR(14) typically runs 50–80 pips. GBP/JPY runs 100–200 pips. Same percentage move = different dollar swing.
The percentage of trades that close in profit — winners divided by total closed trades.
Win rate alone says almost nothing about profitability. A 90% win rate can lose money if losses are 10× the size of wins; a 30% win rate can compound nicely if winners are 5× the losers.
Also called:
hit rate, winning percentage
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