Value at Risk (VaR) is a risk measure which many traders use as a way of assessing their exposure to price. They create a number by looking at the mark to market and assessing how volatile the market is at any one point, they assume a normal distribution of volatility and apply standard deviations away from the normal. So they have a 95% confidence in a mtm move of x over a particular trading product.

Sophisticated VaR models look at correlations and aggregate up all manner of risks so that eventually the risk manager or MD or financial guy can look at this one number and apply a limit to it. The beauty is that it reacts with the market. The more you hedge the less exposed you are and the more you are exposed to near dated products the higher the volatility the higher the VaR number.

VaR is not a pancea to trading, it really only works as a risk measure the more choppy the market the more opportunity to make or lose money and the less a risk manager would want a player to risk. Or put another way if you have 20MW of power which is exposed to a market price if the market vol is 20% and your potential loss is £400k then the risk manager would be happy with this. If however, the vol moves to 40% you now have the potential to lose £800k without changing your position. VaR acts as a tolerance to overall exposures.