What does the Risk Adjustment (Ra) attribute tell about a trading strategy / DARWIN?

The Risk Adjustment Investable Attribute (Ra) evaluates the level of intervention required in a DARWIN by our risk manager. The more the Risk Manager has to intervene, the lower the Ra score will be.

What is it?

The Risk Adjustment Investable Attribute (Ra) evaluates the level of intervention required in a DARWIN by our Risk Manager. The more the Risk Manager has to intervene, the lower the Ra score will be and vice versa.

Darwinex' Risk Manager acts as an overlay to the underlying strategy thereby ensuring that the DARWIN trades with a known target monthly risk level of 10% VaR. 

This Investable Atrribute is scored from 0-10 and is calculated taking into account the last 12 D-Periods of Experience (Ex).

1. DARWIN behaviour vs. Underlying Strategy

The lower the required intervention by our Risk Manager, the more similar the shape of the return curves of the DARWIN and underlying strategy will be.

This doesn't mean the DARWIN and underlying strategy will have the same return, since a DARWIN trades with a fixed target monthly VaR of 10%, while the monthly VaR of the underlying strategy can be anywhere from almost 0% to 99.99999%.

2. Known level of risk

The Darwinex Risk Manager transforms a strategy with a given risk into a financial asset - a DARWIN - with a target monthly VaR of 10% at the 95% confidence interval level.

The higher the Ra score, the less frequent the interventions of the Risk Manager which increases the probability that the actual observed monthly VaR tends towards 10%.

It should be noted that while the Risk Adjustment attribute (Ra) evaluates the trader's risk management at the position levelthe overall risk management od the trading strategy is measured by the Risk Stability (Rs) attribute.

A stable risk level at the aggregate trading account level, combined with a consistent level of leverage at the position level, gives investors security that the shape of the DARWIN curve will be faithful to that of the underlying strategy. This combination results in high scores in the Rs and Ra atrributes. 

The Ra attributes evaluates the risk per position, independently of the position size.

Where can I see the Risk Adjustment (Ra) score?

DARWIN Page

As with the other Investable Attributes you can find this information in the upper right corner of a DARWIN page.

Barra Atributos

Investable Attributes tab

Within a DARWIN page, click on the Investable Attributes tab and then on Ra in the horizontal menu.

There you will find a bubble graph.

Risk Adjustment

The graph has two axis:

  • The vertical axis (logarithmic scale) shows the D-Leverage per position within the trading strategy.
  • The horizontal axis represente the duration of the position, or length of time that it remained open.

We can observe three types of bubbles on the graph:

1. Green bubbles

Green bubbles represent positions that have not required intervention by our Risk Manager, as they have not significantly exceeded the average leverage of the recently opened positions on the underlying strategy.

2. Red bubbles

Red bubbles represent positions that have required intervention by our Risk Manager. In these instances the leverage employed was considered too high relative to the average of recent positions.

By moving your mouse over the bubble, the exact size of the adjustment can be seen. Logically enoughm an adjustment of 5% can't be considered the same as an adjustment of 60%. The latter adjustment would provoke a much higher penalty to the Ra score than the former.

Risk adjustment example

3. Orange bubbles

The manager can also intervene when the DARWIN leverage is excessive when using the previously mentioned formula, even when the global DARWIN risk for 1 month does not exceed a 10% VaR.

This happens when the underlying strategy always trades short term with relatively few trades a month.  In these instances, if there were no adjustment, the DARWIN could reach a leverage of over 30:1 in some cases.  This is dangerous for investors if in the time of the trade being open there is a very big movement on the underlyings (0.5% of movement on the underlying assets would result in a sudden loss of 15% on the DARWIN).

This is why there is a limit on the DARWIN leverage, meaning there are position which are closed without sticking to a target monthly VaR of 10%.

The leverage limits applied by Darwinex are the following:

  • For positions lasting less than 30 minutes, the maximum D-Leverage allowed will be 15.
  • If a position lasts between 30 and 60 minutes, the maximum D-Leverage that a DARWIN could open is 12.5.
  • Lastly, if the position lasts more than 60 minutes, the maximum D-Leverage would be 10.

The orange bubbles offer an approximate indication of the adjustment carried out.  These adjustments, unlike the ‘red ones’, do not affect the score because we do not consider them to be a result of bad management by the trader.

Examples of Risk Adjustment (Ra) scores

As commented earlier, a graph full of green bubble is indicative of a strategy with a high Ra score. Conversely, a graph full of red bubbles would be indicative of a strategy with a low Ra score.

High Ra score

The below graph, full of green bubbles, is a good example of where the Risk Manager has not had to intervene. Consequently, the strategy will have a high Ra score.

Good grade Ra

Low Ra score

The below example contains multiple cases of intervention by the Risk Manager. Not only has the intervention been frequent however, in many of those instances the adjustment required has been substantial, resulting in a low Ra score.

Low grade Ra

DARWIN D-Leverage

DARWIN D-Leverage is thus calculated with the following formula:

D-Leverage DARWIN formula

It is important to understand that the maximum leverage is defined as a function of duration of the position, as the longer a position is left open, the greater the risk incurred.

As such the Risk Manager acts throughout the life of the position and not just upon opening of the position.

Risk Manager behaviour when faced with increased risk

The Risk Manager adjusts investor leverage in order to achieve a target monthly VaR of 10%. But what happens when a trader suddenly increases the risk of the strategy?

1. Increasing the number of trades in the same asset in the same direction

If a trader decides to open many trades in the same asset and same direction in short order, the D-Leverage will increase in line with the number of trades since the correlation between them is +1.

In this instance, the strategy VaR might not have time to update to reflect this new reality. Our Risk Manager will recalculate a new VaR for the strategy - calculated across the last 45 trading days with open positions - and adjust the DARWIN positions in accordance with the formula outlined above so that the DARWIN D-Leverage does not drag the monthly VaR above the 10% target level.

2. Trades in different assets

If the new trades are in a different underlying than the trades that make up the position, the Risk Manager will evaluate the correlation of the new trade and the other trades. In the event of a sudden increase in D-Leverage due to high correlation with the existing trades, the Risk Manager will act in exactly the same way as the previous example. The higher the correlation, the higher the risk and the bigger the adjustment.

Want to know more?

If you want to know more about Risk Adjustment, watch webinar recording.

 

Blog articles announcing on current Risk Manager: Part 1, Part 2 and Part 3