One thing to understand before diving into all the different risk measures is defining what the severity of a risk violation means. So far, we've been discussing risk violations as being maximum risk limit violations. But in practice, there are multiple levels of every risk limit, and each level of risk limit violation is not equally as catastrophic to algorithmic trading strategies. The lowest severity risk violation would be considered a warning risk violation, which means that this risk violation, while not expected to happen regularly, can happen normally during a trading strategy operation. Intuitively, it is easy to think of this as, say, on most days, trading strategies do not send more than 5,000 orders a day, but on certain volatile days, it is possible and acceptable that the trading strategy sends 20,000 orders on that day. This would be considered an example of a warning risk violation – this is unlikely, but not a sign of trouble. The purpose of this risk violation is to warn the trader that something unlikely is happening in the market or trading strategy.

The next level of risk violation is what would be considered as something where the strategy is still functioning correctly but has reached the limits of what it is allowed to do, and must safely liquidate and shut down. Here, the strategy is allowed to send orders and make trades that flatten the position and cancel new entry orders, if there are any. Basically, the strategy is done trading but is allowed to automatically handle the violation and finish trading until a trader checks on what happens and decides to either restart and allocate higher risk limits to the trading strategy.

The final level of risk violation is what would be considered a maximum possible risk violation, which is a violation that should never, ever happen. If a trading strategy ever triggers this risk violation, it is a sign that something went very wrong. This risk violation means that the strategy is no longer allowed to send any more order flow to the live markets. This risk violation would only be triggered during periods of extremely unexpected events, such as a flash crash market condition. This severity of risk violation basically means that the algorithmic trading strategy is not designed to deal with such an event automatically and must freeze trading and then resort to external operators to manage open positions and live orders.