Risk capital
Family III · Risk
Not to be confused with forex risk, correlation risk, gap risk.
Risk capital is money set aside specifically for trading or investing that the owner can afford to lose entirely. It is not the same as total account balance or net worth; it is the amount beyond emergency reserves, debt obligations, and essential expenses. Because it is expendable, risk capital defines the maximum acceptable loss from a trading strategy.
How risk capital is determined
Risk capital is calculated by subtracting essential commitments from liquid assets. Essential commitments include living expenses, debt payments, tax liabilities, and emergency savings. The remainder is the amount available for speculative activity. Brokers and regulators may set minimum margin or suitability requirements, but these vary by jurisdiction and firm; they do not define an individual's risk capital.
For a trading plan, risk capital is often expressed as a percentage of total liquid assets. A common conservative guideline is to risk no more than 1–2% of risk capital on a single trade, though this is a personal choice and not a universal rule.
Worked example
If the trader adopts a 2% single-trade loss limit, the maximum loss per trade is £1,100 (2% of £55,000). This figure is independent of the broker's margin requirements or the size of the trading account.
Risk capital versus account equity
Account equity is the current value of a trading account, including open positions. Risk capital is a broader personal or institutional measure of what can be lost without consequence. A trader may have £100,000 in an account but only £20,000 of risk capital if the remaining £80,000 is needed for other purposes. Position sizing based on account equity rather than risk capital can lead to losses that impair essential financial security.
Often confused with
- forex risk
- Forex risk is the specific exposure to currency price movements and leverage in foreign exchange trading, whereas risk capital is the amount of money set aside to absorb any trading loss; the visible sign is that forex risk is measured in pips or currency exposure, while risk capital is a cash amount.
- correlation risk
- Correlation risk is the danger that supposedly independent positions move together and amplify losses, while risk capital is the finite pool of funds available to cover those losses; the visible sign is that correlation risk is a statistical relationship between assets, whereas risk capital is a balance-sheet figure.
- gap risk
- Gap risk is the possibility that a market jumps between prices without trading, causing a stop-loss to execute at a worse level than planned, whereas risk capital is the total amount that can be lost; the visible sign is that gap risk appears as a price chart discontinuity, while risk capital is a predetermined cash limit.