Trading Glossary

Your average loss is how much you lose on a typical losing trade. To find it, add up all your losses and divide by the number of losing trades. If four losing trades cost $600 in total, your average loss is $150 ($600 ÷ 4). Keeping it small, and smaller than your average win, is what gives a strategy a lasting edge.

Your average win is how much you make on a typical winning trade. To find it, add up all your profits and divide by the number of winning trades. If five winning trades made $1,500 in total, your average win is $300 ($1,500 ÷ 5). Together with your average loss and win rate, it decides your expectancy.

Drawdown is the drop in your account equity from a peak to the following trough, usually shown as a percentage. If your account falls from $10,000 to $8,000 before recovering, that is a 20% drawdown. Maximum drawdown is the largest peak-to-trough fall on record, measuring the worst losing stretch a strategy has put you through.

An equity curve is a line chart of your account balance over time, plotted trade by trade or day by day. A smooth curve rising from the bottom left to the top right points to a steady edge, while a jagged or falling curve flags inconsistency or a strategy that has stopped working.

Expectancy is the average profit or loss you can expect from each trade over a large sample. It blends your win rate with the size of your average winner and average loser into one number. A positive expectancy means a strategy makes money on average; a negative one loses, no matter how you size it.

A holding period is the length of time a position stays open, measured from the entry fill to the final exit fill. Traders track the average holding period, and compare it for winning and losing trades, to see whether their exits follow the plan and which hold times actually pay.

The Kelly criterion is a formula that calculates the fraction of your account to risk on each trade so the account grows as fast as possible over the long run, given your win rate and the size of your wins relative to your losses. For trading it reads Kelly % = W − (1 − W) ÷ R.

Maximum adverse excursion, or MAE, is the furthest a trade moved against you at any point while it was open, measured from your entry. A trade that dipped $1.20 below your entry before closing at a profit has an MAE of $1.20. Recorded across many trades, MAE shows how much room your winners actually needed.

Maximum favorable excursion, or MFE, is the furthest a trade moved in your favor at any point while it was open, measured from your entry. A trade that ran $3.00 up before you closed it for $1.80 has an MFE of $3.00. Compared with what you actually banked, it shows how much of each move your exits are capturing.

Position sizing is how you decide the quantity to trade so that a loss costs a fixed, pre-chosen amount. You take your risk budget for the trade, usually a small percentage of your account, and divide it by the distance from your entry to your stop-loss. The stop sets the distance, and the arithmetic sets the size.

Profit factor is gross profit divided by gross loss across all your trades. It tells you how many dollars you make for every dollar you lose. A profit factor above 1.0 means a strategy is net profitable, 1.5 to 2.0 is generally considered strong, and below 1.0 means it loses money.

An R-multiple expresses a trade's result as a multiple of the amount you risked. Your initial risk, the distance from entry to stop, equals 1R. Risk $100 and make $300, and the trade is +3R; lose the full $100, and it is −1R. R-multiples let you compare trades of any size on one scale.

Risk of ruin is the probability that a trading strategy, run at a given position size, loses enough of the account to force you to stop before its edge has time to play out. Ruin can mean losing everything or hitting a drawdown limit you set in advance. It depends on win rate, payoff size, and above all on how much you risk per trade.

Risk per trade is the amount of your account you accept losing on a single trade, usually written as a percentage of current equity. A trader risking 1% of a $25,000 account puts $250 on the line per trade. It is the dial that decides how deep a normal losing streak can dig, and it is set before the trade, not during it.

The risk-reward ratio compares how much you stand to lose on a trade to how much you aim to gain. Risk $100 to make $300 and your ratio is 1:3. You set it before you enter, from your stop and target, and it decides how often you need to be right just to break even.

A setup in trading is a specific, repeatable set of market conditions that must all be present before you take a trade, together with the event that triggers the entry and the price that proves the idea wrong. Defining setups precisely lets you group trades and measure each pattern's results separately.

The Sharpe ratio measures how much return a strategy earns for each unit of volatility it carries. It is the average return above the risk-free rate divided by the standard deviation of those returns. A trader who made 18% in a year with 10% volatility, against a 4% risk-free rate, has a Sharpe ratio of 1.4.

Slippage is the difference between the price you expected to trade at and the price your order actually filled at. It usually works against you, on entries and on stop-loss exits alike, and it comes from market orders, fast or gapping markets, thin liquidity, and orders larger than the size available at the quoted price.

The Sortino ratio measures how much return a strategy earns for each unit of downside risk. It divides the return above a target, usually zero or the risk-free rate, by the downside deviation, which only counts returns that fall below that target. Unlike the Sharpe ratio, it doesn't penalize big winning days.

A stop-loss is an order that closes a trade once price reaches a level you set in advance, capping what the trade can cost you. The distance from your entry to that level is your risk on the trade, the amount traders call 1R, and it decides both your position size and how every result gets measured afterwards.

The System Quality Number (SQN) is Van Tharp's score for how reliable a trading system's edge is. It divides the average R-multiple by the standard deviation of R-multiples and multiplies by the square root of the number of trades, usually capped at 100. A higher SQN means the edge is large compared with the noise around it.

A take-profit is an order that closes a trade once price reaches a target you set in advance, locking in the gain at that level. It is usually a limit order, so it fills at your price or better. Together with the stop-loss it defines the trade's planned reward, its risk-reward ratio, and the win rate the setup needs to break even.

A trading plan is a written set of rules that covers what you trade, when you trade, how much you risk, which setups you take, how you exit, and how you review results. Its job is to make every trade checkable, so you can tell a bad strategy apart from a strategy you did not follow.

Win rate is the percentage of your trades that close with a profit, calculated as winning trades divided by total trades. A 55% win rate means 55 of every 100 trades were winners. On its own it says nothing about whether you make money, because it ignores the size of your wins and losses.

The win/loss ratio is the number of winning trades divided by the number of losing trades. Win 60 trades and lose 40, and your win/loss ratio is 1.5. It is not the same as your win rate, and on its own it says nothing about how big your wins and losses are.