Every term you need to know before trading a prop firm challenge. Drawdown types, risk metrics, evaluation rules, and more.
Backtesting is the process of testing a trading strategy on historical data to evaluate how it would have performed. It provides statistical metrics like win rate, expectancy, and max drawdown for the strategy.
Balance-based drawdown calculates losses based on your account balance (closed trades only), not including floating profits or losses from open positions. This method is more forgiving than equity-based drawdown.
The Calmar ratio divides annualized return by the maximum drawdown experienced during the same period. It specifically measures how well returns compensate for the worst-case drawdown scenario.
The challenge phase is the first stage of most prop firm evaluations. Traders must hit a profit target (typically 8-10%) within a time limit while respecting drawdown and daily loss rules.
Commission is the fee charged by a broker for executing a trade, typically charged per lot or per trade. It's separate from the spread and is a direct cost that reduces your net profit on every trade.
The consistency rule requires that no single trading day accounts for more than a certain percentage (typically 30-40%) of your total profit. It prevents traders from passing challenges through one lucky trade.
The daily loss limit is the maximum amount you can lose in a single trading day before your account is violated or suspended. It resets at the start of each new trading day based on the firm's timezone.
Day trading involves opening and closing all positions within the same trading day. It's the most common trading style for prop firm accounts because it avoids overnight risk and aligns with daily drawdown calculations.
Drawdown type refers to the specific method a prop firm uses to calculate drawdown limits. The main types are balance-based, equity-based, trailing intraday, and trailing end-of-day, each with different implications for risk management.
End-of-day trailing drawdown adjusts the drawdown floor based on your account equity at the end of each trading day, rather than tracking real-time intraday equity highs. This is more forgiving than intraday trailing.
An equity curve is a graphical representation of your account value over time. A rising curve indicates profitability, while a smooth curve indicates consistent performance with small drawdowns.
Equity-based drawdown includes both realized and unrealized (floating) profits and losses in the drawdown calculation. If your open positions are in the red, that floating loss counts against your drawdown in real-time.
The evaluation phase is the testing period where prop firms assess a trader's skill before granting a funded account. Most firms use a two-phase evaluation consisting of a Challenge and a Verification phase.
Expectancy is the average expected profit per trade, calculated as: (Win Rate x Average Win) - (Loss Rate x Average Loss). A positive expectancy means the system is profitable over a large sample of trades.
Forward testing (walk-forward testing) runs a trading strategy on live market data in real-time to validate backtest results. It bridges the gap between backtesting and live trading with real capital.
A funded account is a live trading account provided by a prop firm after a trader successfully passes the evaluation phases. The trader keeps a percentage of profits (typically 70-90%) while the firm provides the capital.
Leverage allows traders to control a position larger than their account balance. A 1:100 leverage means $1,000 of capital controls $100,000 in position value. Higher leverage magnifies both profits and losses.
A lot is a standardized unit of measurement for trade size. In forex, one standard lot equals 100,000 units of the base currency. Mini lots are 10,000 units and micro lots are 1,000 units.
Lot size refers to the number of units of a financial instrument in a trade. In forex, a standard lot is 100,000 units, a mini lot is 10,000, and a micro lot is 1,000. In futures, lot sizes vary by contract.
Margin is the collateral required to open and maintain a leveraged position. It's expressed as a percentage of the total position value. If margin requirements are 1%, you need $1,000 to control a $100,000 position.
Max consecutive losses is the longest streak of losing trades in a row. Understanding this metric is critical for position sizing because it determines the worst-case drawdown from a string of losses.
Max drawdown is the maximum total loss allowed from your account's starting balance (or high-water mark) before the account is terminated. It represents the absolute floor your equity cannot breach.
Monte Carlo simulation runs thousands of randomized sequences of your historical trades to estimate the probability distribution of outcomes, including worst-case drawdowns and ruin scenarios.
Paper trading (demo trading) is the practice of simulating trades without real money to test strategies, learn platforms, and build confidence. It uses live market data but virtual funds.
A payout is the withdrawal of profits from a funded prop firm account. Payouts are subject to the firm's profit split, minimum thresholds, and schedule (typically bi-weekly or monthly).
A pip (percentage in point) is the smallest standard price increment in forex trading, typically the fourth decimal place (0.0001) for most currency pairs. For JPY pairs, it's the second decimal place (0.01).
Position sizing determines how many lots or contracts to trade based on your account size, risk tolerance, and stop loss distance. Proper position sizing ensures no single trade can significantly damage your account.
Profit split is the percentage division of trading profits between the prop firm and the funded trader. Standard splits range from 70/30 to 90/10 in favor of the trader, with some firms offering up to 100% on initial payouts.
A profit target is the minimum profit percentage you must achieve during an evaluation or challenge phase to advance to the next stage or receive a funded account. Typical targets range from 5% to 10%.
A prop firm (proprietary trading firm) provides traders with company capital to trade in exchange for a share of the profits. Traders typically pass an evaluation to prove their skills before receiving a funded account.
R-multiple expresses a trade's profit or loss as a multiple of the initial risk (1R). If you risk $500 and make $1,500, that's a 3R trade. This standardizes performance measurement regardless of position size.
Recovery factor is calculated by dividing net profit by maximum drawdown. A recovery factor of 3.0 means you generated 3x as much profit as your worst drawdown. Higher values indicate more efficient use of risk.
Risk per trade is the maximum dollar amount or percentage of account equity you're willing to lose on a single trade. Most prop traders risk between 0.5% and 2% of their account per trade.
Risk-reward ratio (R:R) compares the potential loss to the potential gain on a trade. A 1:2 ratio means you risk $1 to potentially gain $2. Higher ratios allow profitability even with lower win rates.
A scaling plan is a prop firm program that increases a funded trader's account size and sometimes profit split based on consistent profitable performance over time. It rewards traders who demonstrate long-term discipline.
Scalping is a trading style that involves taking many small, quick trades lasting seconds to minutes. Scalpers aim for small profits per trade but high volume, which can be effective for prop firm consistency rules.
The Sharpe ratio measures risk-adjusted return by dividing the average excess return by the standard deviation of returns. A higher Sharpe ratio indicates better return per unit of risk taken.
Slippage occurs when an order is executed at a different price than expected, typically during high volatility or low liquidity. It can cause your stop loss to fill at a worse price than set, increasing your actual loss.
The spread is the difference between the bid (sell) and ask (buy) price of an instrument. It represents a trading cost — you immediately start every trade at a small loss equal to the spread.
A stop loss is a predetermined price level at which a losing trade is closed to limit the loss. It defines the maximum risk on a trade and is essential for calculating position size and protecting drawdown limits.
Swap (rollover) is the interest fee charged or credited for holding a forex position overnight. It's based on the interest rate differential between the two currencies and is applied daily at the rollover time.
Swing trading involves holding positions for multiple days to weeks, capturing larger price moves. Some prop firms restrict or prohibit overnight and weekend holding, which limits swing trading strategies.
A take profit is a predetermined price level at which a profitable trade is closed to lock in gains. Combined with the stop loss, it defines the risk-reward ratio of a trade setup.
Trade management refers to the decisions made after entering a trade: adjusting stop losses, taking partial profits, moving to breakeven, and determining when to close. Good trade management maximizes winners and limits losers.
A trading journal is a systematic record of all trades including entry/exit prices, position size, strategy, reasoning, and outcomes. It enables traders to identify patterns, improve decision-making, and track prop firm compliance.
A trading plan is a comprehensive written document that defines your strategy rules, risk parameters, entry/exit criteria, and daily routine. It removes emotion from trading decisions by providing clear guidelines to follow.
Trailing drawdown is a dynamic loss limit that moves upward with your account's equity high-water mark but never moves back down. Unlike fixed drawdown, the floor rises as you profit, reducing your available risk cushion over time.
Weekend holding refers to maintaining open positions from Friday market close through to Monday's open. Many prop firms prohibit this due to the risk of price gaps that could breach drawdown limits.
Win rate is the percentage of trades that result in a profit. While important, win rate alone doesn't determine profitability — it must be evaluated alongside the average risk-reward ratio.
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