Risk & Psychology Flashcards

All 31 terms in this deck

The full list, for reference and search.

Backtesting

Backtesting is running a precisely defined set of trading rules against historical data to measure how it would have performed.

Bag Holder

A bag holder is a trader left holding a position far below cost after the move that attracted them has died, now waiting indefinitely to "get back to even." The term is standard market vocabulary, usually applied to buyers who arrived late in a pump or a fading momentum name and never took the stop.

Behavioral Finance

Behavioral finance studies how psychological biases and emotions cause investors to make decisions that deviate from purely rational, self-interested behavior, and how those deviations show up in market prices.

Black Swan Event

A black swan event is a rare, extreme, and largely unpredictable occurrence with severe consequences, a term popularized by Nassim Nicholas Taleb, that is only widely understood as significant in hindsight.

Confirmation Bias

Confirmation bias is the tendency to seek out, favor, and remember information that confirms an existing belief while ignoring or discounting information that contradicts it.

Drawdown

Drawdown is the decline from an account's equity peak to its subsequent low, quoted as a percentage of that peak.

Expectancy

Expectancy is the average amount a trading approach makes or loses per trade: expectancy = (win rate x average win) - (loss rate x average loss).

FOMO

FOMO — fear of missing out — is the urge to buy a stock because it is already running and everyone else seems to be getting paid.

Hedging

Hedging is holding an offsetting position so that a loss in one holding is partly or fully canceled by a gain in another.

Kelly Criterion

The Kelly criterion is a formula for the bet size that maximizes long-run compound growth: Kelly fraction = edge / odds.

Leverage

Leverage is control of a position larger than the cash behind it, using borrowed money or derivatives, so that gains and losses are computed on the full position size rather than the equity.

Loss Aversion

Loss aversion is the well-documented tendency for the pain of losing money to feel more intense than the pleasure of gaining the same amount, a core finding of behavioral economics research by Daniel Kahneman and Amos Tversky.

Maintenance Margin

Maintenance margin is the minimum equity, as a percentage of position value, that a margin account must hold after a position is opened.

Margin

Margin is money borrowed from a broker to buy securities, with the account's holdings as collateral.

Margin Call

A margin call is a broker's demand for more cash or securities after account equity falls below the maintenance margin requirement.

Overtrading

Overtrading is taking substantially more trades than a strategy actually signals — filling dead hours with C-grade setups, re-entering after stops, trading for stimulation instead of edge.

Paper Trading

Paper trading is placing simulated trades with fake money against real market quotes, used to test a strategy or platform before risking capital.

Position Sizing

Position sizing is the calculation that decides how many shares or contracts to trade so that a losing trade costs a fixed, predetermined slice of the account.

R Multiple

An R multiple states a trade's outcome as a multiple of the amount risked at entry: R multiple = profit or loss / initial risk.

Revenge Trading

Revenge trading is jumping back into the market immediately after a loss to win the money back, typically with larger size and no qualifying setup.

Risk of Ruin

Risk of ruin is the probability that losses drive an account down to a level it cannot recover from — either literal zero or the point where the trader can no longer size positions meaningfully.

Risk-Reward Ratio

The risk-reward ratio compares what a trade can lose against what it can plausibly make: the distance from entry to stop versus the distance from entry to target.

Sharpe Ratio

The Sharpe ratio is excess return per unit of volatility: (portfolio return - risk-free rate) / standard deviation of returns.

Sortino Ratio

The Sortino ratio is the Sharpe ratio with one change: the denominator counts only downside volatility, so returns above the target do not count against the strategy.

Stop Loss

A stop loss is a predefined exit that closes a losing position once price reaches a set level, capping the damage from a trade that did not work.

Sunk Cost Fallacy

The sunk cost fallacy is the tendency to keep investing time or money into something because of what has already been invested, rather than evaluating the decision fresh based on its current merits.

Systematic Risk (Market Risk)

Systematic risk is the risk inherent to the entire market or economy, like a recession, a rate hike, or a geopolitical shock, that affects nearly every asset to some degree and cannot be eliminated through diversification.

Take Profit

A take profit is a resting order, usually a limit order, that closes a winning position automatically at a predetermined target price.

Unsystematic Risk (Diversifiable Risk)

Unsystematic risk is risk specific to a single company or industry, like a factory fire, a failed product launch, or a lawsuit, that does not affect the broader market.

Volatility

Volatility is the standard deviation of an asset's returns — a statistical measure of how widely results scatter around their average, quoted as an annualized percentage.

Win Rate

Win rate is the percentage of trades that close at a profit — and by itself it says nothing about whether a trader makes money.