Value at Risk (VaR) is a statistical tool that helps forex traders estimate the potential loss of a portfolio over a specific time period, given a certain level of confidence. In simple terms, VaR answers the question: “What is the maximum loss I can expect over a set period under normal market conditions?” For example, a one-day 95% VaR of $1,000 means there’s only a 5% chance the loss will exceed $1,000 in a single day.

Traders can calculate VaR using three main methods: historical simulation, variance-covariance, and Monte Carlo simulation. The historical method relies on past price data, the variance-covariance approach assumes a normal distribution of returns, and the Monte Carlo method generates simulated outcomes using random variables. Each technique provides different levels of accuracy and complexity.

Using VaR allows traders to gauge how much capital they should allocate, how to set stop-loss levels, and whether their exposure aligns with their risk tolerance. It’s particularly useful for institutional traders and fund managers who need to maintain a consistent risk framework.

However, VaR has limitations—it assumes normal market conditions and cannot predict extreme events or “black swan” scenarios. Therefore, traders should use VaR alongside stress testing, scenario analysis, and other risk management tools to build a more complete picture of potential losses.