Learn total portfolio exposure limits — Stock-Market notes

WHY does an exposure limit exist?

$\text{Recovery gain} = \frac{1}{1 - L} - 1$

where $L$ is the fractional loss.

WHY this formula? If you lose fraction $L$ , your capital becomes $(1-L)$ of the original. To get back to $1$ , you must multiply by $\frac{1}{1-L}$ . The extra return needed is that minus 1.

WHAT exactly is "exposure"?

Two different limits therefore exist:

HOW to derive the risk-per-trade → portfolio-risk link

Let:

$C$ = total capital
$r$ = risk per trade as a fraction of capital (e.g. 1% → $r=0.01$ )
$n$ = number of simultaneous open trades

Step 1 — Risk of one trade. Risk in rupees per trade $= r\cdot C$ . Why? You define risk-per-trade as a fixed fraction so every trade "hurts" equally.

Step 2 — Worst-case total risk (all stops hit). $R_{\text{total}} = n \cdot r \cdot C$ Why? In the pessimistic (correlated) case, all positions stop out together, so the losses add.

Step 3 — Impose the portfolio limit. Set a maximum allowable total risk $R_{\max} = E\cdot C$ , where $E$ is your total exposure/risk cap (e.g. 6%). $n\cdot r \cdot C \le E\cdot C \;\Rightarrow\; \boxed{\,n_{\max} = \dfrac{E}{r}\,}$

HOW to compute an actual position size

To risk $r\cdot C$ on a trade, given entry price $P$ and stop price $S$ :

Step 1 — Risk per share $= |P - S|$ . Why? That's the loss you eat on each share if the stop triggers.

Step 2 — Shares $= \dfrac{r\cdot C}{|P-S|}$ . Why? Total rupee risk ÷ risk per share = number of shares that produces exactly that risk.

Figure — Learn total portfolio exposure limits

Correlation: why the simple sum is a worst case

Common mistakes (Steel-manned)

Recall Feynman: explain to a 12-year-old

You have a bag of 100 candies (your money). A game lets you win candies but sometimes you lose some. Rule: never put more than a few candies on the table at once — say 6 total across all your bets. That way if you have a horrible round and lose everything on the table, you still have 94 candies left to keep playing tomorrow. If you dumped all 100 on the table and lost, the game's over — you can't play at all. The exposure limit is just: "how many candies am I allowed to have on the table at the same time?"

Flashcards

Define total portfolio exposure limit

The maximum % of total capital allowed to be at risk (or deployed) across all open positions at any one time.

Difference between exposure (deployed) and risk (at risk)?

Deployed = money committed =

Q\cdot P

; Risk = money lost if stops hit =

Q\cdot|P-S|

. A tight stop means high deployment but low risk.

Formula for max concurrent positions

n_{\max} = E/r

where

E

= portfolio risk cap,

r

= risk per trade.

With 1% risk/trade and a 6% portfolio cap, how many open trades?

0.06/0.01 = 6

trades.

Position size formula given entry P and stop S

Q = \dfrac{r\cdot C}{|P-S|}

Gain needed to recover a 50% loss?

100% (

\frac{1}{1-0.5}-1

Why is worst-case total risk

n\cdot r\cdot C

and not less?

It assumes all positions are correlated and stop out simultaneously, so losses add — the pessimistic survival case.

How does correlation affect real risk vs the formula?

Low correlation makes real risk lower than

n\cdot r\cdot C

; high correlation makes the worst-case realistic.

Why cap exposure at all?

Losses need asymmetrically larger gains to recover; capping keeps any bad streak survivable so your edge can play out.

Connections

Risk & Money Management
Position Sizing
Stop-Loss Placement
Risk per Trade Rule (1% Rule)
Correlation & Diversification
Leverage and Margin
Drawdown and Recovery Math
Kelly Criterion

Concept Map

Hinglish (regional understanding)

Intuition Hinglish mein samjho

Dekho, trading me sabse pehli cheez hai survival — profit baad me aata hai. Total portfolio exposure limit ka matlab hai: ek time pe apne total capital ka kitna hissa "risk pe" rakh sakte ho. Bahut saare log sochte hain "maine sirf 20% paisa lagaya hai, safe hoon" — par yaad rakho, deployed money aur risk money alag cheezein hain. Agar stop-loss door hai to thoda paisa bhi bada risk ban jaata hai.

Core formula simple hai: agar har trade me tum 1% risk lete ho ( $r=0.01$ ) aur poore portfolio ka risk cap 6% rakhte ho ( $E=0.06$ ), to maximum kitne trade ek saath khol sakte ho? $n = E/r = 6$ . Bas! 7th trade tab tak nahi, jab tak koi purana close na ho. Yahan capital $C$ cancel ho jaata hai, isliye ye rule chhote ya bade account dono pe kaam karta hai.

Position size nikalna bhi easy hai: rupee risk ( $r\times C$ ) ko risk-per-share ( $|Entry - Stop|$ ) se divide karo — utne shares lo. Isse har trade ka risk barabar rehta hai, chahe stock ka price kuch bhi ho.

Aur recovery ka math hamesha yaad rakhna: 50% loss ke baad wapas aane ke liye 100% gain chahiye, 90% loss pe 900% gain! Isiliye exposure cap zaroori hai — chhota loss recoverable hota hai, bada loss game khatam kar deta hai. Ek cheez aur: agar saare trades ek hi sector ke hain (high correlation), to "sab stop ek saath" wala worst case sach ho sakta hai, isliye formula pessimistic maanke chalta hai. Mantra: "SIX to SURVIVE, n = E over r."

Test yourself — Risk & Money Management

Connections