How does the risk engine work?
- 05 Apr 2023
- 2 Minutes to read
How does the risk engine work?
- Updated on 05 Apr 2023
- 2 Minutes to read
Article Summary
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How the Risk Engine works
The Darwinex Zero Risk Engine is an algorithm that manages the risk of DARWINs independently of the risk taken by the trader.
The risk engine is the mechanism that lies in between the signal account and the DARWIN, thereby regulating DARWIN risk and ensuring that the target risk of all DARWINs is the same (6.5% maximum monthly VaR).
DARWIN Risk Engine Intervention
The Risk Engine works on two levels:
Trade initiation
Every time a trader sends a market order and depending on the market conditions at that moment in time, the algorithm calculates the size to be opened for the DARWIN in order to meet the target risk level that Darwinex Zero guarantees all its potential investors (6.5% monthly VaR).
Trade adjustment
While the trader's position remains open in the market, the Risk Engine takes into account the market conditions throughout the position's lifespan, as well as the duration of the open position. The algorithm may determine that a second level of risk adjustment is required in order to ensure that the position does not go above the maximum permitted D-leverage.
D-Leverage Thresholds
- Maximum D-Leverage of 16.25 for positions of less than 15 minutes.
- Maximum D-Leverage of 13 for positions lasting between 30 and 60 minutes.
- Maximum D-Leverage of 9.75 for positions that last more than 60 minutes.
This means that the Risk Engine can act at any moment in time to partially close the position so that the DARWIN's target risk level never goes above 6.5% monthly VaR.
DARWIN Risk Engine formula and example
Lev (investor) = Lev (trader) * (target VaR/strategy VaR)*f
Strategy VaR
As a reference period and, in order to evaluate the signal account's value at risk (VaR), the algorithm uses the last 45 days in which the trader has remained exposed to the market.
Target VaR and VaR Ratio
To determine the DARWIN's target VaR, historical VaR data is taken into account, starting with the most recent data with a look-back window of 6 months max, until the ratio between the maximum and minimum VaR is 2:1.
Should the DARWIN never exceed this 2:1 ratio in the last 6 months, Darwinex Zero will take into account the last 6 months.
Then, the current VaR of the DARWIN is divided by the maximum VaR calculated before.
Lastly, this ratio gets multiplied by 6.5%, resulting in a VaR that will move between 3.25% - 6.5%.
Examples
Current VaR: 8%
Maximum VaR: 12% one month ago
Minimum VaR: 6% five months ago
Target VaR: (8%/12%)*6.5% = 4.33%
Current VaR: 9%
Maximum VaR: 14% 2 months ago
Minimum VaR: 8% in the last 6 months
Target VaR: (9%/14%)*6.5% = 4.17%
In summary, the Risk Engine tolerates changes in VaR up to factor of 2 (up or down) with the objective of better adapt to how the traders manage their risk.
VaR Ratio = (Target VaR/Strategy VaR)
VaR Ratio can be checked at Darwin Live trades.
"VaR Ratio" is the leverage ratio between a DARWIN and an underlying strategy.
For instance, if the VaR Ratio is 2, it means that the DARWIN is trading with leverage of 2 times higher than the underlying trading strategy. On the other hand, if the VaR Ratio is 0.5, it means that the DARWIN is trading with half the leverage when compared with the underlying trading strategy.
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