The school · trading under rules
Prop firm rules, explained
A prop firm evaluation is a risk test with a profit target attached. You trade a firm's account under its rules, and breaking any one of them ends the attempt, however good the rest was. The usual rules are a daily loss limit (how much the account may lose in one day), a maximum drawdown (how far it may fall overall), which can be static — fixed from the starting balance — or trailing — following the account's high-water mark up — a consistency rule that caps how much of the profit can come from one day, and a minimum number of trading days. Some firms measure losses on equity, including open trades, rather than on closed balance. Turning each limit into a number of risk units before the first trade is what keeps a losing streak from ending the evaluation.
What is the difference between static and trailing drawdown?
Static drawdown is measured from a fixed level, usually the starting balance, and never moves. Trailing drawdown follows the account's highest point (its high-water mark), so every new high lifts the line you must not fall below — a profit can make the remaining room smaller.
How do you size trades for a daily loss limit?
Express the limit in units of the risk you take per trade. If the daily limit is five times your risk per trade, five losses in a row in one day end the attempt — so decide in advance how many losses you will take before stopping for the day, well inside the limit.
Module
Trading under someone else's rules
A prop firm evaluation is a risk test with a profit target attached. The module
- Prop firm
- A proprietary trading firm: a company that gives traders access to its capital, usually after they pass a paid evaluation, in exchange for a share of any gains.
- Evaluation
- The qualifying stage of a prop firm, also called a challenge: an account with a profit target and loss limits. Breaching a loss limit ends the attempt; missing the target only means it is not passed yet.
- Profit target
- The gain an evaluation account must reach to pass, usually quoted as a percentage of the starting balance. The rule people read first, and the one that decides the fewest failures.
- Daily loss limit
- The most an evaluation account may lose in one trading day before the attempt ends. Most useful known as a number of losing trades, with its reset time converted to local time.
- Maximum drawdown
- How far the account may fall below a reference level in total before the attempt ends. Static if the reference is fixed; trailing if it follows the account's highest point.
- Static drawdown
- A drawdown floor fixed at the start, such as 90,000 on a 100,000 account. Gains move the account away from it, so room grows as the account grows.
- Trailing drawdown
- A drawdown floor that rises with the account's high-water mark and never falls back. Gains lift the floor rather than buying room, so room is always measured from the latest high.
- High-water mark
- The highest value an account has reached so far. A trailing drawdown is measured from it, which is why a pullback from a new high can leave little room even while the account is up.
- Equity
- The account balance plus the current value of every open position. A limit measured on equity counts a losing open trade immediately; a limit on balance counts only closed trades.
- Consistency rule
- A rule that no single day may account for more than a set share of total profit. It filters out passes built on one oversized day, and can raise the total needed after a large win.
- Minimum trading days
- The number of separate days on which trades must be placed before an evaluation can pass. It delays a pass; it never ends an attempt.
- A limit in R
- A loss limit divided by the risk per trade: the number of losing trades the rules can absorb. The same 5% limit is ten losses at 0.5% per trade and two at 2%.
- Losing streak
- Consecutive losses, which cluster by chance. Even at a coin-flip hit rate, the longest run over a hundred trades is typically around six.
- Stop distance
- The gap between the entry price and the stop, measured in the instrument's own unit — points, ticks or pips. Read off the chart before anything about money is decided.
- R
- The money lost if the stop is reached: one trade's worth of being wrong. Every other number in the trade — target, result, slippage — is quoted as a multiple of it.
- R-multiple
- A result expressed in R: +2R made twice what was risked, −1R lost exactly the planned amount. It makes trades in different instruments and account sizes directly comparable.
- Risk budget
- The fixed amount of money one trade is allowed to cost, chosen in advance. It does not grow because a setup looks better than usual, and it does not shrink because the stop is wider.
- Risk per trade
- The risk budget expressed as a percentage of the account — for example 0.5% or 1%. On a 10,000 account, 1% risk per trade means one R is 100.
- Position size
- The number of units, lots or contracts in a trade: risk budget ÷ (stop distance × point value). An output of two decisions already made, never a starting point.
- Invalidation
- The price at which the reason for a trade stops being true — usually a piece of structure breaking. The stop sits just beyond it.
- Point value
- What a one-point move is worth for one lot or contract of an instrument. It is the bridge between a stop distance on the chart and a loss in money.
- Pip
- The standard unit of price movement in currency pairs — usually the fourth decimal place (0.0001), or the second (0.01) for yen pairs. Indices and metals are more often measured in points or ticks.
- Lot
- A standardised trade size. In currency pairs a standard lot is 100,000 units of the base currency, a mini lot 10,000 and a micro lot 1,000; other instruments define a lot in their own contract terms.
- Risk-reward ratio
- The distance to the stop compared with the distance to the target, written 1:2 or "2R". A measurement of two distances — it says nothing about how often either is reached.
- Drawdown
- How far an account has fallen from its highest point, usually as a percentage. Recovery is asymmetric: a 20% drawdown needs a 25% gain to repair, a 50% drawdown needs 100%.
- Leverage
- Borrowed exposure: control of a position larger than the cash put up for it, such as 1:30. It lowers the margin required; it does not change what the stop costs.
- Margin
- The deposit a broker holds while a leveraged position is open. It is collateral, not the amount at risk — the loss at the stop is set by distance, point value and size.
- Beyond, not on
- A stop placed outside a level's own noise rather than inside it, so that reaching it means the idea was refuted — not that price merely brushed the level it was built on.
- The controllable input
- Position size. The market sets the fill, whether the stop is reached and how far a move runs; the number of units is the one part of a trade nobody else has a vote in.
- Outcome
- What actually happened to a position, written down once it is closed. Every closed position is one, including the scratches and the ones closed early.
- The missing rows
- Trades that were taken and never recorded. They are not a random sample — they lean toward losses and toward the trades nobody is proud of.
- Win rate
- The share of recorded trades that closed in profit. On its own it says nothing about whether an approach makes money — it has to be read beside the average win and loss in R.
- Sample size
- How many trades a figure rests on. At twenty, an approach that truly wins half the time routinely shows anything from six to fourteen winners, so twenty says almost nothing about an edge.
- Expectancy
- The average result per trade, measured in R: win rate times average win, minus loss rate times average loss. Together with the win rate it tells the whole story; either one alone is close to meaningless.
- Process versus outcome
- Two separate judgements about one trade: whether the decision would be made again knowing only what was known at the time, and what it happened to pay. A good decision loses regularly.
- Trade journal
- The written record of every trade taken: the plan, the numbers and the outcome. Its value depends entirely on completeness — a journal missing its losses describes a trader who does not exist.
- Selection bias
- A distortion caused by which data made it into a set rather than by the data itself. In a trade journal, the unrecorded trades lean toward losses, so the recorded win rate is inflated.
- Outcome bias
- Judging the quality of a decision by its result. It rewards lucky bad trades, punishes sound ones that lost, and slowly replaces a tested process with a superstitious one.
- Scratch
- A trade closed at or near breakeven, often by hand and early. It is still an outcome and belongs in the record — scratches are among the rows most often left out.
- Variance
- The natural scatter of results around their true average. Over small samples it is large enough to make a sound approach look broken and a weak one look brilliant.
- Edge
- A genuine, repeatable advantage — a positive expectancy that holds up over a large sample. It cannot be seen in a handful of trades, only in a complete record of many.
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