Risk limit calibration
How should a trader's risk limits be sized when calm weeks and fast weeks behave so differently?
In plain words
Risk limit calibration is the process of choosing position sizes, stop distances and loss caps from a reference measure of past market behaviour, often recent volatility or typical weekly range.
Why it matters
Limits built on calm weeks assume the market keeps moving gently. When volatility expands sharply, the same sizing rule allows positions the market can no longer carry, and losses arrive faster than the limits were designed to absorb.
In a real week: ETH, week of 31 August 2020
ETH's four weeks before 31 August 2020 returned 4.75%, 11.14%, -9.89% and 9.78%, but the week beginning 31 August 2020 returned -17.75% with a 58.5% range and 140.2% realised volatility. Volume reached 3.38 times the prior 12-week average. Limits sized on the preceding weeks would have allowed exposure that the week's swing could overwhelm.
A common mistake
Assuming the most recent calm stretch is a stable baseline. Calibration windows that exclude fast weeks systematically understate how far prices can travel in a short period.