I want to report results of my research and share my opinion about it.
My thesis is that the current market conditions are highlighting a potential problem in the VaR system.
Let’s start with the research and study I made on the current variable VaR system:
|Date||Investor’s VaR||My VaR||Ratio||Darwinex Ratio|
From the results of March, you can appreciate that even if the underlying strategy’s VaR is changing, investors’ VaR is moving in order to keep the same ratio (in my case, 1.62).
This is a huge improvement, in my opinion. It erases the problem of having different risks in different periods, since the ratio seems to be quite stable over time, allowing investors’ to follow the same curve of the underlying, although with a different risk.
Darwinex deserves double thumbs up for this
This period of high volatility, though, is highlighting a potential serious problem of the system.
When the personal VaR increases over a certain point (my point is 6.17%), the ratio cannot be the same anymore, because investors’ VaR is capped at 10%.
So with a personal VaR going towards 10%, the ratio becomes smaller and this changes the behavior of the Darwin.
There are two potential outcomes:
The trader keeps following the system. VaR increases during this period of high volatility, the ratio becomes smaller, this decreases the risk for investors, while keeping the same risk for the trader;
The trader reduces the risk, this will reduce the VaR and the risk for both, trader and investor, but will keep the ratio constant. Results for investors is the same as outcome 1, they will follow the Darwin with a lower risk.
What when this crazy volatility will end? VaR will go down again. Investors will go back to the normal risk.
So, right now, with high volatility, there is no way to avoid a reduced risk for investors. When this period is over, VaR will go down and risk for investors will increase again, going back to normal, to the situation before this period.
The problem is that this leaves a lot of space for luck and not for trading skills.
What if the Darwin has a good period during the time VaR increases (less risk and less profits for investors) and then a bad period when VaR goes back to normal (normal risk and normal profits for investors)? The Darwin would lose money just because of the VaR, while the underlying would probably make money or break even.
Opposite, some Darwins can be lucky and have a bad period now that VaR is increasing (reducing the risk and profits for investors), then have a good period when the VaR goes back to normal (normal risk and profits for investors).
This is not only affecting my Darwin, but a quick look at top Darwins’ VaR, and we can immediately see what I’m talking about.
Right now, VaR is going up for most Darwins and ratio starts to decrease at a certain point, changing the normal proportion between the underlying and the Darwin.
Not only this, for Darwins with personal VaR above 10%, ratio starts to decrease immediately and dramatically. Fortunately, it is not my case.
My humble opinion is that this period proved that VaR calculated on 45 trading days is too short and can lead to tremendous changes like the one experiencing now, even if traders are keeping the same risk per trade.
This is a post just to show what I think, supported by some data. Then, obviously, it’s up to Darwinex to decide if it is the case to consider a longer period than 45 trading days for the VaR.