Who this chapter is for — Readers who want to understand how much exposure they are taking, what can be controlled before an order, and which events may make realised loss differ from planned loss. It starts with the fundamentals and remains useful when reviewing professional models, limits and procedures.
Risk management is the set of definitions, measurements, limits and procedures used to make a possible loss identifiable, sizeable and sustainable. It does not remove uncertainty or turn a stop into a guarantee. It separates what is planned from what the market, product, intermediary and trading venue may actually produce.
This chapter reconstructs established knowledge and practice. It does not present a proprietary strategy and does not retrospectively apply the rules of the Emiciclo Method.
Visual map: from sizing to survival
The stages are connected, but they are not synonyms. A trade budget is not a margin requirement; margin is not notional value; drawdown is not one loss; risk of ruin is not the certainty that a particular losing streak will occur.
| Stage | The right question | What it does not promise |
|---|---|---|
| How much do we plan to lose if the idea is invalidated and the exit follows our assumptions? | a guaranteed cap on realised loss | |
| What quantity fits the budget, distance, point value, costs and lot size? | execution of the stop at its intended price | |
| What is the economic value of the controlled exposure? | how much capital will be lost | |
| What is the ratio between exposure and the relevant capital or margin? | a unique effect without stating what remains constant | |
| What collateral does the product require and when is it recalculated? | equivalence with risk per trade | |
| Which rules apply when collateral no longer meets requirements? | a certain exit price or the absence of a deficit | |
| How far is equity below its previous peak, and for how long? | the worst possible future decline | |
| Under which model, boundary and horizon do we estimate ruin probability? | a universal probability outside the assumptions |
1. Before the order: budget, invalidation, quantity
The process starts with the hypothesis, not with the available leverage. Define where the idea is no longer valid, translate that distance into monetary risk per unit, and derive a quantity compatible with the budget. Futures, FX, CFDs and non-linear instruments require further specifications: tick value, contract multiplier, currency conversion, payoff and minimum lot.
A simplified linear form is:
planned risk ≈ quantity × stop distance × point value + estimated costs
The result is an estimate. Gaps, thin liquidity, slippage, commissions and order mechanics may produce a different exit. A journal should therefore preserve both planned R and realised R.
2. Exposure, leverage and margin: three different layers
Notional value describes economic exposure; leverage is a ratio; margin is collateral required under a contractual model. Treating them as the same hides the actual size of the position.
For a linear instrument, notional may be calculated as quantity times price, including any contract multiplier. The same leverage ratio can lead to different outcomes:
- at fixed notional, higher leverage may reduce initial margin without changing price exposure;
- at fixed margin, higher leverage increases notional and monetary sensitivity to market moves;
- costs, financing, requirements and possible loss depend on the product and cannot be inferred from “10×” alone.
Initial margin, maintenance margin, available capital, and isolated or cross arrangements do not operate identically across markets. Documentation from the broker, clearing house and venue is part of the calculation, not a footnote.
3. Liquidation: a threshold and a process, not a planned stop
When an account or position no longer meets its requirements, the risk manager may request funds, reduce exposure or close it. The process may be partial or full and may use reference prices other than the last trade. The trigger, liquidation order and average execution price are different events.
Rules differ among securities lending, futures, CFDs and crypto derivatives. In some regimes an intermediary may sell assets without waiting for instructions; elsewhere a venue may use liquidation engines, insurance funds or deleveraging procedures. None of these designs makes a stop unnecessary or guarantees that loss remains within initial collateral.
4. After the trade: path, drawdown and ruin
One loss does not describe the vulnerability of a programme. Drawdown measures the distance between current equity and the previous peak; depth, duration and recovery all matter. A 20% decline requires a 25% gain from the trough to regain the peak: loss and recovery percentages are asymmetric.
Risk of ruin adds a probability question: what is the probability that capital touches a stated boundary within a defined horizon? The answer depends on the outcome distribution, sizing rule, capital, costs, leverage, dependencies and regime changes. A simulation is informative only when it exposes data, assumptions, seed or sampling method, and result sensitivity.
Risk-reading checklist
Before treating a plan as complete:
- what is the hypothesis, and what event invalidates it?
- is the budget monetary, percentage-based or expressed in R?
- have distance and costs been translated into the account currency?
- what is total notional, including correlated positions?
- what remains constant when leverage is discussed?
- which margins, reference prices and liquidation rules does the product use?
- which gaps, liquidity constraints or operational errors may exceed the plan?
- how are current drawdown, observed maximum and duration measured?
- what does “ruin” mean, and over which horizon is it estimated?
- do live data, backtests and simulations include costs and adverse scenarios?
The second ring: from trade to system
Once the eight foundations are distinct, the next step is to measure loss tails, aggregate positions and dependencies, build scenarios, and control liquidity, models, operations and intermediaries.
Open Risk measurement and control →
From there, the third ring shows how capital, concentrations, budgets, contributions and sensitivities coexist without becoming interchangeable quantities.
Explore Risk allocation and sensitivities →
Sources
- CME Group — Proper Position Size
- CME Group — About Contract Notional Value
- CME Group — Performance Bonds/Margins FAQ
- CFTC — Understand the Risks of Virtual Currency Trading
- Investor.gov — Margin Call
- FINRA — Brokerage and Advisory Accounts