Portfolio heat
After this lesson you can compute your book's open risk in one minute, and you'll run the two limits that institutions never trade without.
Open risk
School II taught risk per trade. This school scales it to the book, and the first step is a number almost no retail trader can quote about their own account: open risk, also called portfolio heat. It's the total loss, in euros and in R, if every open position hit its current stop today.
The computation is School II's arithmetic, summed. For each position: (entry price − current stop) × shares, floored at zero. That's what closing at the stop costs you against what you paid, so a stop raised to or above your entry contributes nothing. Then add. A worked book, account €20,000, R = €200 (1%):
| Position | Shares | Entry | Price | Current stop | Risk if hit |
|---|---|---|---|---|---|
| A (fresh entry) | 40 | €50.00 | €50.00 | €45.00 | €200 = 1.0R |
| B (fresh entry) | 90 | €22.00 | €22.00 | €19.80 | €198 ≈ 1.0R |
| C (at +1.5R, stop raised) | 60 | €30.00 | €35.00 | €28.00 | €120 = 0.6R |
| D (freerolled, stop at breakeven) | 25 | €74.00 | €81.00 | €74.00 | €0 |
| Total open risk | ≈ €518 ≈ 2.6R |
The worst ordinary day this book can inflict, every stop hit and no gaps, is about 2.6% of the account. Look at position D. It holds €2,000 of stock and adds nothing at all to the heat, because course-craft from School V moved its stop to breakeven. Heat is a function of where the stops sit. The size of the book barely enters into it, and a large book can carry less heat than a small one.
The two limits
Professional risk desks cap this number, and the two caps go together. Adopt both as contracts in the School II sense.
The open-risk limit. Total heat may not exceed a ceiling — say 3R (3% of the account) while learning. When the book is at the ceiling, it makes no difference what the checklist approves; there's no risk budget left, and a new entry waits until a stop-raise or an exit frees some. This cap is what makes a losing streak survivable at the book level: School II, course 1's arithmetic applied to the whole account at once.
The daily new-risk limit. A separate, smaller cap on risk added in one day — say 2R. Its job is pacing. Without it, one enthusiastic morning can load the entire ceiling into a single day's judgment, and School VII covers what that kind of morning usually turns out to be. Good markets serve up entries for weeks, so spreading the ceiling across days keeps any one day's mood from setting the whole book's risk.
The mechanics of living with the limits: compute heat every day (it takes about a minute, since the journal already holds every stop), and check both caps as layer zero of School V's checklist, before regime. The Arena computes it for you and refuses entries past either cap, which is roughly what a professional's order-entry system does.
Check yourself
- Compute: three positions risking 0.9R, 1.0R and 0.7R to current stops; one freerolled at breakeven. Heat? Room under a 3R ceiling? (2.6R. Yes — 0.4R of budget, which won't fit a full new 1R position, so the answer is to wait.)
- Why does heat use current stops rather than initial ones? (Heat is today's worst ordinary case. Raised stops have already retired risk; the number must say so.)
- What does the daily limit protect that the ceiling alone doesn't? (The pacing — it stops one morning's judgment from carrying the whole book's risk budget.)
The habit this lesson installs
Know your book's heat every day, and trade behind both caps.
Next: Course 2 — "Correlation: when five positions are one trade."