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Risk Management & Capital Allocation Flashcards

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  1. A trader has a $50,000 account and uses a 2% risk-per-trade rule. After 10 consecutive losses, approximately how much capital remains?

    Answer: $41,342

    With 2% risk per trade compounded, after 10 losses: $50,000 × (0.98)^10 ≈ $41,342.

  2. Which risk management approach adjusts position size based on recent market volatility, typically using Average True Range (ATR)?

    Answer: Volatility-based position sizing

    Volatility-based position sizing uses ATR to normalize risk so that each trade risks approximately the same dollar amount regardless of the asset's volatility.

  3. A trader enters a long position at $100 with a stop-loss at $95 and a profit target at $115. What is the Risk-to-Reward ratio?

    Answer: 1:3

    Risk is $5 (100-95) and reward is $15 (115-100), giving a 1:3 risk-to-reward ratio.

  4. What does 'correlation risk' refer to in portfolio management?

    Answer: The risk that positions believed to be uncorrelated move together during stress events

    Correlation risk is the danger that assets assumed to be diversifying actually move together during market stress, eliminating the expected diversification benefit.

  5. Which of the following best describes 'expected value' (EV) in the context of a trading strategy?

    Answer: The probability-weighted average outcome of all possible trade results

    Expected value is calculated as (win rate × average win) − (loss rate × average loss), representing the average outcome per trade over many repetitions.

  6. A professional trader who risks 1% per trade with a 2:1 reward-to-risk ratio needs a minimum win rate above what percentage to be profitable?

    Answer: 33%

    At a 2:1 reward-to-risk ratio, the breakeven win rate is 1/(1+2) = 33.3%, so any win rate above ~33% yields positive expectancy.

  7. What is a 'drawdown' in trading?

    Answer: The decline from a peak equity value to a subsequent trough before a new peak is reached

    Drawdown measures the peak-to-trough decline in account equity before a new high is made, reflecting the magnitude of losing periods.