Risk Tolerance
The maximum level of financial loss and psychological discomfort a trader can absorb without deviating from their strategy.
Risk tolerance is both financial and psychological. Financially, it defines how large a drawdown you can sustain without depleting capital to an irrecoverable level. Psychologically, it defines how large a drawdown you can sustain without abandoning your strategy prematurely.
Many traders discover their true risk tolerance only after experiencing live losses. Someone who theoretically accepts a 20% drawdown may actually abandon a strategy at −8% due to psychological stress. Calibrating position sizes well below the financial maximum ensures the psychological threshold is never breached.
Related Terms
Capital Preservation
The principle of protecting trading capital above all else — because you cannot trade without capital, survival is the first objective.
BeginnerDrawdown
The peak-to-trough decline in account equity from a high point to the subsequent low before a new high is reached.
BeginnerMoney Management
The set of rules governing how capital is allocated, how large positions are, and how losses are limited across a portfolio of trades.
BeginnerRisk of Ruin
The statistical probability that a trader will lose enough capital to be forced out of trading entirely, given their edge and risk per trade.
AdvancedRisk Per Trade
The percentage or dollar amount of your account you are willing to lose on a single trade. Typically 0.5–2% for most traders.
Beginner