Managing risk in the strategy
Day 19 of 26 · 9 min read · By DT Terminal
Sizing one trade is the start. A strategy also needs limits above it: a daily loss limit and a cap on trades, weekly and maximum drawdown limits, a rule for correlated positions and for cutting size in a drawdown. This lesson builds that plan, shows why risk of ruin depends on size, and how prop firm limits fit inside it.
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From one trade to a risk plan
In Day 4 you sized one trade. That protects you from one trade. It does not protect you from ten in a bad week, or the angry trade after the third loss.
A risk plan is the set of limits above the single trade. Each is a bigger box around the one before, and each says in advance what you do when it is reached. One example plan:
You need not copy these numbers. What matters is that every layer exists, is written down before you trade, and that reaching it means you stop.
Go deeper
Sizing one trade means picking a percentage, putting the stop where the idea is wrong, and working out the lots. A limit you decide in the moment is not a limit.
The moment you most want to break a limit is the moment after a run of losses, when your judgement is at its worst. That is why the limits are written first.
A daily loss limit and a max trades per day
A daily loss limit is the most you let yourself lose in a day. Reach it and you stop until tomorrow. At 1% a trade, a 3% limit is 3R: three full losses.
A max trades per day caps the count, win or lose. Whichever comes first ends the day.
Worked example
Example 01: One bad Monday on a $10,000 account
The worked example, with every number walked through, is in the app.
Set the limits in the Risk Engine
Go deeper
In the example the setups are the same both ways. The only difference is whether the day had an end, and the limit counts the day's closed losses. Check the projection against your daily and weekly caps.
Measure the daily limit from the balance you started the day with, in percent or in R. The trade cap does the same job from the other side: a choppy day cannot turn into ten small entries that each felt reasonable.
A common pairing while you learn is a daily limit of 2% to 3% and a cap of 2 or 3 trades. In the example you risk 1% of $10,000; the two extra trades at double size are 2 x $200 more, the usual attempt to win it back.
Weekly and maximum drawdown limits
A drawdown is how far the account has fallen from its highest point. A weekly limit stops a bad run of days; a maximum drawdown is the floor under the whole plan.
Stop early, because every percent lost takes more than a percent to win back:
| Drawdown | Gain needed to get back |
|---|---|
| 5% | 5.3% |
| 10% | 11.1% |
| 20% | 25.0% |
| 30% | 42.9% |
| 40% | 66.7% |
| 50% | 100.0% |
| 75% | 300.0% |
Write an action next to each limit:
- Weekly limit reached (say 6%): no live trades until Monday. Review the week.
- Maximum drawdown reached (say 10% from the peak): stop trading live; go back to demo or the backtester.
Go deeper
Why the gain needed is bigger: a loss comes off a bigger number than the gain that repairs it. Review the week against your rules when the weekly limit is reached.
A monthly limit works like the weekly one. At the maximum drawdown, go through every trade since the peak and find out whether the losses came from the strategy or from breaking it. Stay on demo or the backtester until you have a reason to return.
Hitting the floor means something changed: the market, the strategy or you. Stopping gives you the chance to find out which, with most of the account still there to act on the answer.
Correlated positions are one bigger bet
Two pairs are correlated when they tend to move together. EURUSD and GBPUSD are both priced in US dollars, so a long on each is one bet against the dollar, taken twice.
DT Terminal ChartsEURUSD · H1DT Terminal ChartsGBPUSD · H1Worked example
Example 02: Two longs against the dollar
The worked example, with every number walked through, is in the app.
| Pair | Often moves | Why |
|---|---|---|
EURUSD and GBPUSD | Together | Both are priced in US dollars |
EURUSD and USDCHF | Opposite | The dollar sits on opposite sides of the two |
XAUUSD and the dollar | Opposite, often | Gold is priced in dollars, so a stronger dollar tends to weigh on it |
US500 and NAS100 | Together | Both are baskets of large US companies |
Go deeper
Same hours, two longs: EURUSD long at 1.08650 and GBPUSD long at 1.27050. One dollar release takes out both stops on the same candle.
Anything that moves the dollar moves both pairs in the same direction: the climbs, the pullback and the drop line up because the dollar sits on the same side of both. In the example, 0.40 lots of EURUSD is $4 a pip and 0.33 lots of GBPUSD is $3.30 a pip.
If you want both trades, split the risk instead: 0.20 lots and 0.16 lots put about $50 on each, $98 on the idea, which is the 1% you meant to risk. Long EURUSD and short USDCHF are both short the dollar too.
Cutting size in a drawdown, and earning it back
In a drawdown the instinct is to trade bigger. Do the opposite: cut risk per trade once the account is a set distance below its peak, and earn full size back with results.
Worked example
Example 03: Half size at 5% down
The worked example, with every number walked through, is in the app.
Write the size rule into Trading Rules
Go deeper
Trading bigger digs the hole deeper, just when something may be wrong. Many traders cut size this way. At full size the plan says stop at the maximum drawdown; at half size you have room to find out what went wrong. The climb from $9,218.54 is slow, and that is the point: full size comes back when the results do, not when you feel ready.
Another rule worth writing down: "Stop after 3 losses or 3% down in a day". Rules added in Trading Rules appear in the list you tick off in your daily pre-market plan.
Risk of ruin, and your own plan
Risk of ruin is the chance a run of results takes the account to your maximum drawdown, the line where you stop. Even a winning strategy can touch it, because the order of wins and losses is luck.
One strategy: 40% winners at 1:2, which Day 9 showed makes +0.20R a trade. Only the risk per trade changes:
| Risk per trade | Losses in a row to reach 10% | Chance of touching 10% down in 200 trades |
|---|---|---|
| 0.5% | 20 | 1.8% |
| 1% | 10 | 14% |
| 2% | 5 | 37% |
| 5% | 2 | 68% |
At 0.5% a trade the floor is 20 losses away, reached about 1.8% of the time. At 2%, more than a third of the time. Size is what blows accounts.
Interactive tool
Risk plan builder
This interactive tool runs in the app, with your own numbers.
Go deeper
Ruin is a level you cannot or will not trade on from. For a trader with a plan, that is simply the maximum drawdown. You do not need the formula to use the idea, and the edge never changed from row to row: size is what turns a good strategy into a blown account.
You cannot control the order of your wins and losses. You can control how many losses your plan can absorb. Build your own plan in the builder above and see where each limit lands.
How prop firm rules fit your plan
A prop firm challenge, covered in Day 25, comes with its own version of this plan: a maximum daily loss and a maximum overall loss. Breaking the firm's limit ends the account, so yours sit inside it, with room to spare:
| Your plan | The firm’s rule | How they fit |
|---|---|---|
| Risk per trade | Rarely set by the firm | Yours alone. It decides how many losses fit inside each limit |
| Daily loss limit, say 3% | Max daily loss, often 5%, often measured on equity | Keep yours below the firm’s, so a slipped stop or an open trade cannot fail the account |
| Max trades a day | None | Yours alone. It stops the revenge trade before any limit does |
| Maximum drawdown, say 6% | Max overall loss, often 10%, static or trailing | Stop and review with room left, not on the line that closes the account |
| Correlated trades as one | Open trades count together on equity | Two trades on one idea use up the daily room twice as fast |
The buffer matters because the firm usually measures on equity, open trades included. A stop that slips on news, or two correlated trades, can breach a limit your closed trades never touched.
Check yourself
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