Key Trading Terms Every Beginner Must Know

Introduction

As you transition from training to live trading, you will encounter specific terminology that you must understand completely. Misunderstanding these terms can lead to costly mistakes, blown accounts, and failed prop firm evaluations.

This article provides clear, practical definitions of the essential terms used in futures trading, with particular focus on concepts critical for both self-funded traders and those pursuing prop firm accounts. Each term is explained in plain language with concrete examples.

Account and Capital Terms

Drawdown

Definition: Drawdown is the decline in your account value from a peak to a subsequent low point. It measures how much you have lost from your highest account balance.

Two types of drawdown:

Absolute (or Static) Drawdown: Measured from your starting balance or a fixed high-water mark. If you start with $50,000 and your account drops to $47,000, your absolute drawdown is $3,000 or 6%.

Trailing Drawdown: The drawdown limit moves up as your account grows but never moves down. This is common in prop firm evaluations.

Example of trailing drawdown:

• You start with $50,000 and a $2,500 trailing drawdown limit (floor at $47,500)
• Your account grows to $52,000; the floor rises to $49,500
• Your account drops to $50,500; the floor stays at $49,500
• If your account hits $49,500, you breach the drawdown rule

Why it matters: Drawdown limits are the most common reason traders fail prop firm evaluations. Understanding exactly how your drawdown is calculated is essential.

Daily Drawdown (Daily Loss Limit)

Definition: The maximum amount you are allowed to lose in a single trading day. This is typically calculated from your account balance at the start of the day or from the previous day’s closing balance.

Example: If your daily drawdown limit is 2% and you start the day with $50,000, you cannot lose more than $1,000 that day. If your account drops to $49,000, you must stop trading for the day.

Important variations:

• Some prop firms calculate from the start-of-day balance
• Others calculate from the previous day’s end balance including open profits
• Some include unrealized (open) losses; others count only realized losses

Why it matters: Violating the daily drawdown limit results in immediate account termination at most prop firms.

Maximum Drawdown (Overall Drawdown)

Definition: The total maximum decline allowed in your account before it is terminated. This is usually measured from your starting balance or initial high-water mark.

Example: A $100,000 prop firm account with 8% maximum drawdown means your account cannot fall below $92,000 at any point.

Trailing vs. Static:

• Static: The limit is fixed (e.g., never go below $92,000)
• Trailing: The limit moves up with profits but never down

Why it matters: Hitting maximum drawdown means losing your funded account permanently.

Risk Per Trade

Definition: The amount of money you are willing to lose on any single trade if your stop loss is hit. Usually expressed as a percentage of account equity or a fixed dollar amount.

Calculation:

Risk Per Trade = Account Size × Risk Percentage

Example: $50,000 account × 1% risk = $500 maximum loss per trade

Recommended guidelines:

• Conservative: 0.5% per trade
• Moderate: 1% per trade
• Aggressive: 2% per trade (maximum recommended)

Why it matters: Consistent risk per trade is the foundation of sound risk management. Risking too much per trade dramatically increases the probability of account ruin.

Risk of Ruin

Definition: The probability that you will lose your entire trading account (or enough to be unable to continue trading) given your win rate, risk-reward ratio, and risk per trade.

Key factors affecting risk of ruin:

• Lower win rate increases risk of ruin
• Lower risk-reward ratio increases risk of ruin
• Higher risk per trade dramatically increases risk of ruin

Example: A trader risking 10% per trade with a 50% win rate and 1:1 risk-reward has a very high risk of ruin. The same trader risking 1% per trade has a much lower risk of ruin.

Why it matters: Understanding risk of ruin helps you size positions appropriately and avoid overleveraging.

Prop Firm Specific Terms

Evaluation Phase

Definition: The testing period during which you must demonstrate your trading ability by meeting profit targets while respecting drawdown limits and trading rules. Successfully completing evaluation grants access to a funded account.

Common structures:

• One-step evaluation: Single phase with profit target and drawdown limits
• Two-step evaluation: Phase 1 (higher target) followed by Phase 2 (verification with lower target)
• Three-step evaluation: Rare, but some firms add additional verification phases

Example (Two-step):

• Phase 1: Reach 8% profit without exceeding 5% daily or 10% max drawdown
• Phase 2: Reach 5% profit with same drawdown limits
• Pass both phases to receive funded account

Why it matters: Understanding evaluation requirements is essential for planning your approach and managing expectations.

Profit Target (Profit Objective)

Definition: The percentage or dollar amount of profit you must achieve to pass an evaluation phase or qualify for a payout.

Example: An 8% profit target on a $100,000 evaluation means you must reach $108,000 in account equity.

Important considerations:

• Profit targets must usually be achieved within maximum trading days (if applicable)
• Some firms require a minimum number of trading days before you can pass
• Reaching the target does not mean you should stop. Some traders lock in the pass and stop trading

Why it matters: Setting realistic expectations about how long it takes to reach profit targets helps you trade without excessive pressure.

Funded Account

Definition: An account provided by a prop firm after you successfully pass their evaluation. You trade the firm’s capital and receive a share of the profits.

Key characteristics:

• You do not own the capital
• You must follow the firm’s trading rules
• Profits are split according to the firm’s structure
• The account can be terminated for rule violations

Why it matters: Funded accounts allow traders to access significant capital without personal financial risk (beyond evaluation fees).

Profit Split (Profit Share)

Definition: The percentage of profits you keep from your funded account. The remainder goes to the prop firm.

Common splits:

• 70/30 (you keep 70%)
• 80/20 (you keep 80%)
• 90/10 (you keep 90%)
• Some firms offer up to 100% on initial profits with scaling to lower splits

Example: You make $10,000 profit with an 80/20 split. You receive $8,000; the firm keeps $2,000.

Why it matters: Higher profit splits mean more money in your pocket, but often come with stricter rules or higher evaluation fees.

Scaling Plan

Definition: A structured progression that allows you to increase your funded account size based on consistent profitability over time.

Example scaling plan:

• Start: $50,000 account
• After 2 months profitable: Scale to $100,000
• After 4 months profitable: Scale to $150,000
• Maximum: $300,000 or higher

Requirements typically include:

• Minimum profit percentage achieved
• Minimum number of trading days
• No rule violations
• Consistent withdrawal of profits

Why it matters: Scaling plans provide a path to trading larger capital without paying for new evaluations.

Reset

Definition: Paying a fee to restart an evaluation after failing due to drawdown breach or rule violation. Resets typically restore the account to its original state with a fresh evaluation period.

Cost: Usually 50-80% of the original evaluation fee

Example: You fail a $150 evaluation. A reset costs $100 and gives you a fresh start at day one with original balance and drawdown limits.

When to consider a reset:

• You failed due to a specific mistake you can correct
• You were close to passing when you failed
• You have identified what went wrong

When NOT to reset:

• You are consistently failing evaluations
• You do not have a clear understanding of why you failed
• You are chasing losses with repeated reset purchases

Why it matters: Resets can be a reasonable option, but repeated resets indicate a deeper problem with your trading that paying more fees will not solve.

Position and Order Terms

Maximum Lot Size / Maximum Contracts

Definition: The maximum number of contracts or lots you are allowed to hold at any one time. This rule limits your exposure and risk.

Example: A prop firm account may allow maximum 5 ES contracts at once. Even if your margin allows 10 contracts, you cannot exceed 5.

Why it matters: Violating maximum contract limits typically results in immediate account termination.

Leverage

Definition: The ratio of the total value you control to the capital required to control it. In futures, leverage is built into the contract structure through margin requirements.

Example: If you control $250,000 worth of ES contracts with $10,000 in margin, your leverage is 25:1.

Key point: Higher leverage amplifies both profits and losses. It does not change your edge. It only increases volatility of returns.

Why it matters: Understanding leverage helps you size positions appropriately and avoid catastrophic losses.

Margin

Definition: The good faith deposit required to open and maintain futures positions. Not a loan. It is collateral guaranteeing your ability to cover potential losses.

Types:

• Initial margin: Required to open a position
• Maintenance margin: Required to hold a position overnight
• Day trading margin: Reduced margin for intraday positions (closed by end of session)

Why it matters: Insufficient margin results in forced liquidation of positions, often at unfavorable prices.

Trading Rule Terms

News Trading

Definition: Opening or holding positions during major economic announcements and news events. Many prop firms restrict or prohibit this.

Commonly restricted news events:

• FOMC interest rate decisions
• Non-Farm Payrolls (NFP)
• CPI and PPI releases
• GDP announcements
• Central bank speeches

Typical restrictions:

• No new positions within 2-5 minutes before/after news
• Must close all positions before news
• Some firms allow news trading with reduced size

Why it matters: News trading restrictions are a common cause of prop firm account breaches. Always know the rules.

Overnight Holding

Definition: Keeping positions open outside of regular trading hours, typically past 4:00 PM Eastern for US markets.

Prop firm policies vary:

• Some prohibit overnight holding entirely
• Some allow overnight holding with higher margin requirements
• Some allow overnight on specific days only

Risks of overnight holding:

• Gap risk (price opens significantly different from close)
• Higher margin requirements
• Reduced liquidity during overnight session

Why it matters: Unauthorized overnight holding often results in immediate account termination at prop firms.

Weekend Holding

Definition: Keeping positions open from Friday market close through Sunday/Monday market open.

Generally higher risk than overnight holding due to:

• Longer time period for unexpected events
• No ability to exit positions during weekend
• Significant gap potential on Sunday open

Why it matters: Most prop firms prohibit weekend holding. Even self-funded traders should understand the increased risk.

Inactivity Rules

Definition: Requirements to maintain minimum trading activity to keep your account active. Both prop firms and some brokers have inactivity policies.

Examples:

• Must place at least one trade every 30 days
• Funded accounts may be terminated after 30-60 days of inactivity
• Evaluation timers may expire without sufficient activity

Why it matters: Inactivity can result in losing your funded account or evaluation progress.

Payout Terms

Payout

Definition: The process of withdrawing profits from your funded account. Most prop firms have specific payout schedules and requirements.

Common payout structures:

• Bi-weekly payouts (every 2 weeks)
• Monthly payouts
• On-demand payouts (request anytime)

Common payout requirements:

• Minimum profit threshold (e.g., at least $100 in profit)
• Account must be in profit at time of request
• No open positions during payout processing
• Completed minimum trading days since last payout

Why it matters: Understanding payout rules helps you plan when and how to withdraw your earnings.

Payout Methods

Definition: The ways prop firms transfer your profit share to you.

Common methods:

• Bank wire transfer
• PayPal
• Deel or other payment platforms
• Cryptocurrency (some firms)

Processing time: Typically 1-14 business days depending on firm and method

Why it matters: Know how you will receive your money before committing to a prop firm.