Lessons › Risk and money management › Daily loss limits and total open risk
World 5 · Risk and money management · lesson 14 · level 4
Daily loss limits and total open risk
Decide in advance when to stop trading for the day, because upset traders make worse decisions.
In one line
Decide in advance when to stop trading for the day, because upset traders make worse decisions.
Explained simply
Think of a fuse box at home: when too much power flows, the fuse cuts it off before anything burns. A daily loss limit is a fuse for your trading. Once you hit it, trading stops until tomorrow, before one bad day can do real damage.
The lesson
Total open risk, sometimes called portfolio heat, is the sum of what you would lose if every open stop were hit, and many traders cap it, for example at 5% of the account. A daily or weekly loss limit stops trading after a set loss, such as 3%, so one bad day cannot turn into a disaster. These limits only work if they are set before trading starts. Correlated positions should be counted together when you add up heat.
A worked example
Illustrative example: a trader with a balance of 10,000 holds three trades risking 1%, 1.5% and 2%, so total open risk is 4.5% (1 plus 1.5 plus 2). With a 5% cap, a new trade can add only 0.5% (5 minus 4.5), which is 50 (10,000 times 0.005). A 3% daily loss limit on 10,000 stops trading after a loss of 300 (10,000 times 0.03).
The same idea at four levels
- Beginner. Decide before you start how much you can lose today, and stop when you reach it.
- Foundation. Total open risk, or portfolio heat, is the sum of what every open stop would lose.
- Intermediate. Many traders cap heat at about 5% and set a daily loss limit, such as 3%, before trading starts.
- Advanced. Count correlated positions together when adding heat, because their stops tend to be hit together.
- Expert. Experts add a weekly limit too and treat the lock as final, because the urge to break a limit is strongest when judgment is weakest.
Mistakes to avoid
- Setting limits only after losing, when emotions are already running high.
- Ignoring the limit just this once to win the money back.
- Adding up open risk without counting correlated positions as one bet.
Check yourself
What is total open risk?
The sum of what you lose if every open stop is hit. It adds up the risk at every stop.
What does a daily loss limit do?
Stops trading for the day after a set loss. It stops one bad day from growing.
When should you set your limits?
Before trading starts. Limits set in calm moments work best.
What is another name for total open risk?
Portfolio heat. Heat rises as positions add risk.
Open trades risk 1%, 1.5% and 2%. What is the total open risk?
4.5%. 1 plus 1.5 plus 2 is 4.5.
Goal of this lesson: Set limits on total open risk and on losses per day or week.