Risk Management on the CMT Exam
Risk management carries 20% weight on CMT Level 2 — making it the single most important topic. It also features prominently on Level 3 essays.
Full topic weights are in the CMT exam guide 2026.
Position Sizing
Fixed Percentage Method
Risk a fixed % of capital per trade (typically 1–2%):
- Position Size = (Account × Risk%) / (Entry − Stop Loss)
- Example: $100,000 account, 2% risk, $50 to $48 stop = 1,000 shares
Kelly Criterion
f* = (bp − q) / b, where:
- b = odds received, p = probability of winning, q = probability of losing
- In practice, use half-Kelly for safety
Drawdown Analysis
Understanding drawdowns is critical:
| Drawdown | Recovery Required |
|---|---|
| 10% | 11.1% |
| 20% | 25.0% |
| 30% | 42.9% |
| 50% | 100.0% |
The exponential relationship means avoiding large drawdowns is paramount.
Stop-Loss Methods
- Fixed percentage: Set stop at X% below entry
- ATR-based: Use Average True Range × multiplier
- Chart-based: Place below key support levels
- Trailing stops: Move stop up as price advances
Value at Risk (VaR)
- Definition: Maximum expected loss at a given confidence level over a time period
- Example: 95% daily VaR of $50,000 = 5% chance of losing more than $50K in a day
- Methods: Historical, parametric (uses statistical analysis), Monte Carlo
Portfolio Heat
Total portfolio risk across all positions:
- Rule of thumb: total heat should not exceed 6–8% of portfolio
- Correlated positions multiply risk — consider intermarket relationships
Practice risk calculations with our question bank and see the complete guide.
Drawdown Profile — Impact of Position Sizing on Portfolio
Larger positions create deeper drawdowns and longer recovery times
Recovery Required After Drawdown
% gain needed to recover from a given drawdown — exponential relationship