Trading Glossary

Position sizing determines how many units to trade based on your account size, risk tolerance, and stop loss distance. It is the single most important risk management technique because it ensures no single trade can cause catastrophic damage to your portfolio.

Risk-reward ratio (R:R) compares the potential loss to the potential profit of a trade. A 1:3 R:R means you risk $1 to make $3. Combined with win rate, it determines whether a strategy is mathematically profitable over time.

Drawdown is the peak-to-trough decline in your trading account, expressed as a percentage. It is the primary measure of downside risk. A 20% drawdown requires a 25% gain to recover, and a 50% drawdown requires a 100% gain, making drawdown management critical for survival.

A stop loss is a predetermined price level at which you exit a losing trade to limit your loss. It is the most fundamental risk management tool in trading. Without stop losses, a single trade can wipe out months of profits.

Take profit is a predetermined price level at which you exit a winning trade to secure gains. It enforces discipline by removing emotions from exit decisions and is essential for calculating risk-reward ratios.

A margin call is a demand from your broker to deposit additional funds or close positions when your account equity falls below the required maintenance margin. It is a warning that your account is at risk of forced liquidation. Proper position sizing and leverage management prevent margin calls.

The Kelly Criterion is a mathematical formula that calculates the optimal percentage of capital to risk per trade to maximize long-term growth. Full Kelly is too aggressive for most traders, so practitioners use fractional Kelly (typically half or quarter) to reduce volatility while capturing most of the growth.

Risk of ruin is the probability that a trader will lose enough capital to be unable to continue trading. Even a profitable strategy can lead to ruin if the risk per trade is too high. Keeping risk per trade at 1-2% makes the risk of ruin virtually zero for any strategy with positive expectancy.

Maximum drawdown (MDD) is the largest peak-to-trough decline in account equity over a specific period. It represents the worst-case loss scenario a strategy has experienced or is likely to experience. MDD is the primary risk metric used by prop firms and institutional traders.

Risk per trade is the maximum amount of capital you are willing to lose on a single trade, expressed as a percentage of your account. The widely accepted standard is 1-2% per trade. This single parameter has the greatest impact on your long-term survival as a trader.

Profit factor is the ratio of gross profits to gross losses. A value above 1.0 means a strategy is profitable. Professional traders aim for 1.5-2.5. It is one of the most reliable single-number measures of strategy performance.

Win rate is the percentage of trades that result in a profit. However, win rate alone does not determine profitability. A 40% win rate with large winners can be more profitable than a 70% win rate with small winners. Win rate must always be evaluated alongside risk-reward ratio.

A pip (percentage in point) is the smallest standard unit of price movement in forex, equal to 0.0001 for most pairs and 0.01 for JPY pairs. A standard lot pip is worth approximately $10 for EUR/USD. Pips are used to measure price changes, calculate profits, and compare spreads.

Leverage allows you to control a larger position with less capital by borrowing from your broker. A 1:100 ratio means $1,000 controls a $100,000 position. Leverage amplifies both profits and losses equally, making it the primary reason most retail traders blow their accounts.

Backtesting tests a trading strategy against historical data to evaluate how it would have performed. It is essential for validating a strategy before risking real money. However, backtests can be misleading due to curve-fitting, unrealistic assumptions, and overly optimistic fills.

Prop trading (proprietary trading) is a model where firms provide traders with capital in exchange for a share of profits. Modern prop firms like FTMO and Topstep offer funded accounts after traders pass evaluation challenges that test profitability and risk management discipline.

Lot size is the standardized unit of measurement for trade volume. In forex, a standard lot is 100,000 units, a mini lot is 10,000, and a micro lot is 1,000. The correct lot size for any trade is determined by your position sizing formula, not by preference or convention.

Spread is the difference between the bid (sell) and ask (buy) price of an instrument. It represents the broker's primary source of revenue and is a cost paid on every trade. Tighter spreads reduce trading costs, especially for high-frequency strategies.

Slippage is the difference between the expected price of a trade and the actual price at which it is executed. It occurs during fast market conditions, low liquidity, or large order sizes. Slippage is typically negative (unfavorable) but can occasionally be positive (in your favor).

Commission is the fee charged by a broker for executing a trade. It can be a fixed amount per trade, per lot, or per contract. Combined with spread and slippage, commissions form the total cost of trading. High-frequency strategies are most sensitive to commission costs.

An equity curve is a graph showing the growth of a trading account over time. A smooth, upward-sloping equity curve indicates a consistent strategy. Equity curve analysis reveals drawdown patterns, strategy consistency, and can be used as a filter to pause trading during drawdowns.

Expectancy is the average amount you expect to win or lose per trade over a large sample. It combines win rate and risk-reward ratio into a single number. Positive expectancy means the strategy makes money over time; negative expectancy means it loses money. It is the most important number in trading.

Monte Carlo simulation reshuffles your historical trades thousands of times to reveal the full range of possible outcomes, including worst-case drawdowns that a single backtest cannot show.

Fibonacci retracement uses horizontal lines at key ratios (23.6%, 38.2%, 50%, 61.8%, 78.6%) derived from the Fibonacci sequence to identify potential support and resistance levels where price pullbacks may reverse.

Pivot points are mathematically calculated support and resistance levels derived from the previous period's high, low, and close. They are used by floor traders and day traders to identify intraday turning points and define bias direction.

Support is a price level where buying pressure prevents further decline, while resistance is a price level where selling pressure prevents further advance. Together, they form the foundation of technical analysis and define the structure of any market.

A moving average smooths price data by calculating the average closing price over a specified number of periods, helping traders identify trend direction and dynamic support/resistance levels.

ATR (Average True Range) measures market volatility by calculating the average of true price ranges over a specified period, typically 14. Traders use it to set adaptive stop losses, size positions, and assess whether a market is worth trading.

Bollinger Bands consist of a middle SMA with upper and lower bands set at 2 standard deviations. They expand during high volatility and contract during low volatility, helping traders identify squeezes, breakouts, and overbought/oversold conditions.

RSI is a momentum oscillator ranging from 0 to 100 that measures the speed and magnitude of recent price changes. Readings above 70 suggest overbought conditions, below 30 suggest oversold, and divergences between RSI and price signal potential reversals.

MACD (Moving Average Convergence Divergence) measures trend momentum by tracking the difference between a 12-period and 26-period EMA. Signal line crossovers and histogram patterns generate buy and sell signals, while MACD divergence warns of potential reversals.

Candlestick patterns are visual representations of price action within a specific time period, showing the open, high, low, and close. Specific patterns like hammers, engulfing candles, and dojis signal potential reversals or continuations that traders use to time entries and exits.

A trend line is a straight line drawn along swing highs or swing lows on a chart to define trend direction. Ascending trend lines connect higher lows in uptrends, descending trend lines connect lower highs in downtrends, and breaks of established trend lines signal potential reversals.

Volume analysis studies the number of shares, contracts, or lots traded during a given period to confirm trends, validate breakouts, and identify institutional activity. Volume is often called the only truly leading indicator because it reveals the conviction behind price moves.

A market order is an instruction to buy or sell immediately at the best available price. It guarantees execution but not price, making it the fastest order type but subject to slippage in fast-moving or illiquid markets.

A limit order is an instruction to buy or sell at a specific price or better. Unlike market orders, limit orders guarantee your fill price but do not guarantee execution, as the market must reach your specified price for the order to fill.

A stop order becomes active only when a specified trigger price is reached, then executes as either a market order (stop-market) or a limit order (stop-limit). Traders use stop orders primarily for stop losses and breakout entries.

A trailing stop is a dynamic stop-loss order that automatically moves in the direction of profit as price moves favorably, but stays fixed when price moves against you. It locks in profits while allowing winners to run.

A bracket order is a three-part order that combines an entry order with a predetermined stop loss and take profit, creating a complete trade management package that executes automatically. When one exit order fills, the other is canceled.

An OCO (One-Cancels-Other) order links two separate orders so that when one fills, the other is automatically canceled. Traders use OCO for breakout setups (buy stop + sell stop), exit management (stop loss + take profit), and trading range breakouts in either direction.

Trading discipline is the ability to consistently follow your trading plan, rules, and risk management parameters regardless of emotional impulses. It is the single most important trait separating consistently profitable traders from those who blow up their accounts.

Revenge trading is the impulsive behavior of placing trades to recover losses quickly, typically after a losing trade or a series of losses. It involves abandoning your trading plan, increasing position sizes, and making emotionally-driven decisions that almost always result in even larger losses.

FOMO (Fear of Missing Out) in trading is the anxiety-driven impulse to enter a trade because the market is moving without you. It leads traders to chase entries at poor prices, abandon their setup criteria, and take excessive risk -- resulting in consistently negative outcomes.

Loss aversion is a cognitive bias where the pain of losing is psychologically about twice as powerful as the pleasure of an equivalent gain. In trading, this causes traders to hold losers too long, cut winners too short, avoid taking necessary risks, and make irrational decisions that systematically destroy their edge.

A trading plan is a comprehensive written document that defines your trading strategy, risk management rules, entry and exit criteria, position sizing methodology, and daily routines. It transforms trading from impulsive decision-making into a repeatable, measurable business process.

Market sessions are the four major trading periods that correspond to the business hours of the world's largest financial centers: Sydney, Tokyo, London, and New York. Each session has distinct characteristics in terms of volatility, liquidity, and the instruments that are most active, making session awareness essential for timing entries and managing risk.

Liquidity refers to how easily an asset can be bought or sold without significantly affecting its price. High-liquidity markets have tight spreads, deep order books, and minimal slippage, while low-liquidity markets have wide spreads, thin order books, and unpredictable execution -- directly impacting your trading costs and risk.

Volatility measures the magnitude and speed of price changes in a market. High volatility means large, rapid price swings that create both opportunity and risk, while low volatility means small, slow price changes. Understanding and adapting to volatility regimes is essential for proper position sizing, stop-loss placement, and strategy selection.

Correlation measures the statistical relationship between two assets' price movements. Positive correlation (+1) means they move together, negative correlation (-1) means they move oppositely, and zero correlation means no relationship. Understanding correlation is essential for diversification, avoiding hidden concentration risk, and managing portfolio-level exposure.

A gap is a price discontinuity where an asset opens significantly higher or lower than its previous close, creating a 'gap' on the chart with no trading activity in between. Gaps occur due to overnight news, earnings, economic data, or shifts in sentiment, and they have important implications for support, resistance, and trade direction.

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