D-Leverage

At Darwinex we have created our own way of measuring the risk per position - not per trade- , and we have called it D-Leverage.

Introduction

Introducción

The most common way of measuring the risk of a trade is through its nominal leverage. This is done by dividing the nominal volume of a trade by the account's equity. Thus, a trade with a leverage of 5:1 is equivalent to opening a volume 5 times superior to said account's equity.

Therefore, we can reach the conclusion that the greater the leverage, the greater the risk, right?

The answer would be a yes, partly, because this leverage/risk focus does not take into account one fundamental factor when it comes to evaluating the risk of an asset: its volatility:

It is not the same thing to have a trade, with a nominal leverage of 5:1 on the EURUSD, as one with the same leverage on the GBPJPY, as this last trade would tend to be a lot more volatile than the first one.

Consequently, the greater the volatility, the greater the risk, because the asset quote price can move further in a unit of time, and ''more things could happen''.

At Darwinex we have created our own way of measuring the risk per position - not per trade- , and we have called it D-Leverage.

This takes into account the following variables:

  1. Nominal leverage of each one of the trades open simultaneously.
  2. Asset's volatility - or the combination of assets which make up the position.
  3. Correlation => we measure the correlation of all the assets that make up part of the position.
    The greater the correlation, the greater the risk, and viceversa.
  4. Duration => Compares the volatility in terms of the EURUSD for that time period.

The final result is standardised in terms of the EURUSD therefore a position with a D-Leverage of 3, would be the same as opening a trade on the EURUSD with a nominal leverage of 3.

This way of measuring the risk of any position, taking as a reference the EURUSD, is called the D-Leverage.

Thanks to the D-Leverage, you will be able to comprare the risk of all positions regardless of the assets they are composed of, the type of strategy etc.

What would be the D-Leverage of our previous example with the pairs EURUSD and GBPJPY?

Remember that the nominal leverage of each position was.

  • EURUSD 5:1
  • GBPJPY 5:1

If the volatility of the GBPJPY were 20% higher than the EURUSD, the D-Leverage would be:

  • EURUSD 5:1
  • GBPJPY 6:1

The leverage adjusted to the volatility, or the D-Leverage for the GBPJPY, would be 20% higher than the EURUSD (6 to 1).

Thanks to the D-Leverage, you will be able to compare the both risk and reach the conclusion that under the same conditions of nominal leverage, GBPJPY presents more risk than EURUSD.

Case study

In this example, we are going to show you the development of the D-Leverage of three positions.

Imagine that:

  1. You go long on the USDCAD with a nominal leverage of 7:1.
  2. Before closing the trade, you go short on the GBPJPY with a nominal leverage of 5:1.
  3. You close the USDCAD.
  4. Some time later you close the GBPJPY.
Caso Práctico

During this time period, you can see 3 distinct phases:

  1. Position nº1 => made up of a long trade on the USDCAD 7:1
  2. Position nº2 => consists of two trades: long on the USDCAD 7:1 and short on the GBPJPY 5:1
  3. Position nº3 => made up by a short trade on the GBPJPY 5:1

How is the D-Leverage calculated (Bear in mind that, for a time, trades with different nominal leverage and volatility coincide.)

Solution

Let's suppose that, when you open the trades, the volatility of these two pairs is relation to the EURUSD is the following:

  • EURUSD is 40% more volatile than the USDCAD
  • GBPJPY is 20% more volatile than the EURUSD

We can see on the graph the position's progress across time to aid understanding of the example:

Solución

You can see that the D-Leverage has changed vaue across the 3 positions in the following way:

  1. Position nº1 => In this phase there is only one trade open long on the USDCAD, with a nomial leverage of 7:1. However, as in our example the EURUSD is 40% more volatile than the USDCAD, the position's D-Leverage will be 5.
  2. Position nº2 => Here there are two trades with different leverage and volatility. To simplify the calculation, let us suppose that the sum of both leverages, adjusted to the volatility of the EURUSD, and taking into account the correlation of a long trade on the USDCAD, and another short trade on the GBPJPY, we get a D-Leverage of 9
  3. Position nº3 => Lastly, there is only one short trade open on the GBPJPY in the third position whose D-Leverage is 6, as it is 20% more volatile than the EUUSD.
The value of the D-Leverage has changed over the 3 positions in terms of the nominal leverage, volatility and the correlation between the assets which are open simultaneously.

Tips

1. D-Leverage Graph

In the ''Underlying Strategy'' tab of any DARWIN, you will be able to analyse the progress of a strategy's return, together the D-Leverage and the number of simultaneously open trades on each position.

Underlying strategy

2. Risk Adjustment Investable Attribute Graph (Ra)

In the ["Investable Attributes" / "Ra"] tab, you can analyse both the D-Leverage as well as the duration of each position on the underlying strategy.

Ra IA

Do you want to learn more?

If you want to learn more about the D-Levearge, you cannot miss this presentation.