Stock Trading Risk Assessment & Management 2 — Questions and Answers
Question 1: A trader holds a $50,000 position and is willing to risk 2% of their account on a single trade. What is the maximum dollar loss they should accept?
- $500
- $1,000 (Correct answer)
- $2,000
- $5,000
Correct answer: $1,000
2% of $50,000 equals $1,000, which is the maximum acceptable loss per the 2% rule.
Question 2: Which risk metric measures the ratio of potential profit to potential loss on a trade?
- Sharpe ratio
- Risk/reward ratio (Correct answer)
- Beta coefficient
- Standard deviation
Correct answer: Risk/reward ratio
The risk/reward ratio compares the potential profit of a trade to the maximum potential loss.
Question 3: What is 'tail risk' in the context of stock trading?
- Risk from trading penny stocks
- The risk of rare but extreme market events (Correct answer)
- Risk from holding positions overnight
- Risk associated with sector rotation
Correct answer: The risk of rare but extreme market events
Tail risk refers to the probability of rare, extreme events occurring at the tails of a return distribution.
Question 4: A portfolio has a Sharpe ratio of 0.5. Which interpretation is most accurate?
- The portfolio is generating exceptional risk-adjusted returns
- The portfolio earns 0.50% of excess return per unit of risk (Correct answer)
- The portfolio returns are 50% correlated with the market
- The portfolio has a 50% win rate
Correct answer: The portfolio earns 0.50% of excess return per unit of risk
A Sharpe ratio of 0.5 means the portfolio earns 0.50 units of excess return (above risk-free rate) per unit of standard deviation.
Question 5: Which type of order best protects against a gap-down opening when holding a long position overnight?
- Market order placed at open
- Stop-limit order
- Stop-loss order (Correct answer)
- Trailing stop order
Correct answer: Stop-loss order
A stop-loss (stop-market) order triggers a market sell if price gaps below the stop, executing at the next available price.
Question 6: What does 'correlation risk' mean in portfolio management?
- The risk that two assets move together during market stress, reducing diversification benefits (Correct answer)
- The risk of inaccurate price correlations in trading software
- The risk of holding correlated stocks in the same sector
- The risk of incorrectly calculating beta
Correct answer: The risk that two assets move together during market stress, reducing diversification benefits
Correlation risk is the danger that assets assumed to be diversifiers move in tandem during stress events, eliminating diversification benefits.
Question 7: A trader uses 10:1 leverage. If the underlying asset drops 8%, what is the percentage loss on the trader's equity?
- 8%
- 40%
- 80% (Correct answer)
- 100%
Correct answer: 80%
With 10:1 leverage, an 8% move in the underlying is amplified to 80% loss on the trader's actual equity.
Stock Trading Risk Assessment & Management 2
A trader holds a $50,000 position and is willing to risk 2% of their account on a single trade.
What is the maximum dollar loss they should accept?