Why risk rules come first
A strategy will lose sometimes, however good it is. Risk rules decide how much one loss, one bad day or one bad month is allowed to cost. Without them, a single unusual event can erase months of results, and an automated system will keep acting while you are not watching.
Stop-loss types
A stop-loss is not a guarantee. In a fast market or a gap, an order can fill beyond the stop price.
- Fixed percentage or points: exit if price moves a set distance against the entry.
- Volatility-based (ATR multiple): the distance adjusts to how much the instrument normally moves, so quiet and wild periods are treated fairly.
- Trailing stop: the stop follows price in your favour and never moves back, locking in part of a gain.
- Time stop: leave the position if nothing has happened within a set period.
- Square-off time: close intraday positions before the session ends.
Position sizing
Size controls how much a stop-out actually costs. A common approach is to decide the amount you are willing to lose on one trade, then work backwards from the stop distance to the quantity. A wide stop then means a smaller position, and a tight stop allows a larger one, while the money at risk stays the same.
Sizing rules also protect against running several correlated positions that all lose together. Capping total exposure is as important as capping each trade.
Daily and account-level limits
- Daily loss limit: stop trading for the day once losses reach a set amount.
- Maximum open positions: cap how many trades can run at once.
- Maximum drawdown threshold: pause the strategy if the account falls a set distance from its peak, so you review it instead of hoping.
- Kill switch: a single control that stops new orders immediately.
Test the risk rules too
Risk settings change results as much as entries do. Backtest with them switched on, look at the worst drawdown, and ask whether you would really keep running the strategy through it. If the honest answer is no, the rules are too aggressive for you, whatever the return says.
Keep the rules visible
Every limit should be written where you can read it, and every exit explained by a rule you set. If an order was sent or blocked, you should be able to see which rule caused it. That is the difference between automation you control and automation you only hope is behaving.