Day Trading Risk Management 1 — Questions and Answers
Question 1: What is the primary purpose of a stop-loss order in day trading?
- To lock in profits automatically
- To limit the maximum loss on a trade (Correct answer)
- To increase position size
- To delay trade execution
Correct answer: To limit the maximum loss on a trade
A stop-loss order automatically exits a position when the price reaches a specified level, capping the trader's loss.
Question 2: The '1% rule' in day trading risk management states that a trader should risk no more than:
- 1% of total account equity per trade (Correct answer)
- 1% of the stock's price per trade
- 1% of daily trading volume
- 1% of the broker's margin requirement
Correct answer: 1% of total account equity per trade
The 1% rule limits risk per trade to 1% of total account equity, preserving capital during losing streaks.
Question 3: What does a risk-to-reward ratio of 1:3 mean?
- You risk $3 to make $1
- You risk $1 to potentially make $3 (Correct answer)
- You win 3 out of every 4 trades
- Your stop-loss is 3 times your target
Correct answer: You risk $1 to potentially make $3
A 1:3 risk-to-reward ratio means you risk $1 on a trade where the profit target is $3.
Question 4: Which of the following best describes 'drawdown' in day trading?
- The daily profit target
- The peak-to-trough decline in account value (Correct answer)
- The amount withdrawn from a brokerage account
- The margin used for a leveraged position
Correct answer: The peak-to-trough decline in account value
Drawdown measures the decline from an account's peak value to its lowest point before recovering.
Question 5: A trader has a $10,000 account and uses the 2% risk rule. What is the maximum dollar amount they should risk per trade?
- $20
- $100
- $200 (Correct answer)
- $500
Correct answer: $200
2% of a $10,000 account equals $200, which is the maximum risk per trade under this rule.
Question 6: What is 'position sizing' in the context of day trading risk management?
- Choosing the largest possible trade to maximize gains
- Determining how many shares to buy based on risk tolerance (Correct answer)
- Setting the bid-ask spread for a security
- Calculating the margin required by the broker
Correct answer: Determining how many shares to buy based on risk tolerance
Position sizing determines the number of shares to trade so that the dollar risk aligns with the trader's risk limit.
Day Trading Risk Management 1
What is the primary purpose of a stop-loss order in day trading?