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The New Risk Manager 2.0 (Part 1)

For the last few months all of our efforts have been centralised on the launch of “DARWINEX reloaded”. One of the principal new releases of this launch will be the significant change in the functioning of our Risk Manager.

In this post we will explain the four principal releases in the new Risk Manager 2.0

  1. Reduction of the VAR objective of DARWIN to 10%
  2. Change in the formula to calculate the VaR of a DARWIN
  3. New criteria of the closing of a position by the Risk Manager
  4. Maximum D-Leverage by default for all the DARWINS
Before explaining the changes that we are going to introduce, it is important to understand why the RiskManager exists, and why we fixed the initial DARWIN risk at 20% of VaR.

Darwinex is FCA (UK) regulated asset manager, and therefore, has the ultimate responsibility of all the strategies that are quoted on our platform. As every underlying strategy of the DARWINS operates with an unknown risk, (and therefore out of our control ), if we are to permit that the investors replicate directly the underlying strategies of the traders, we would not be able to comply with our legal obligations as a risk manager for the investors.

For this reason, the need was there to devise a mechanism so that Darwinex can control the risk: the Risk Manager

So, how does it work? Very summarised: each time that the trader send an order to the market, his DARWIN ( through the Risk Manager) will replicate the said order in the investor´s accounts, but with a leverage controlled by our algorithms (adjusted as a function of market conditions at that moment). To reiterate, this is a VERY summarised version of how it functions.

 

One of the principal advantages of the Risk Manager form the investor´s point of view , is that all the DARWINS operate with the same risk, allowing the comparison of every DARWIN on a like-for-like basis, with the need to incorporate normalisation ratios of their profitabilities.

On the other hand, with a defined risk, the Risk Manager assumes that the behaviour of the market will be similar to the other, more well known markets to the investor, such as the equity market. Therefore, if the Risk manager did not exist, a generic asset would not exist, ( if the trader operates with whatever risk he chooses, we would be in a similar situation to a market bazaar in which each stall holder would offer a distinct product , that would have no relation to anything else in the market: one would sell sweets, the next carpets etc)

So why a 20% VaR?

Once we have created the Risk Manager, we had to define the level of risk of the DARWINS. The search for what we consider to be an optimum level of risk for the DARWINS has been ongoing since we launched our platform.

Initially, we decided to take advantage of the Beta phase testing of the platform, to offer the investors three levels of distinct risk ( 5%,10% and 20% of VaR). This would help us as an experiment to study the conduct of the initial investors, and from that base, to define the most appropriate risk level for our platform.

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After a test period of eight months, the main conclusions that we arrived at for the investors were.

They diversified their portfolios with an average of 6 DARWINS per account

They preferred the DARWINS with 10% and 20% more than those with 5%

We therefore discarded the DARWINS with 5%, but we continued to doubt which would be the best outcome , 10% or 20% VaR. Finally , we plumped for the 20% because with a diversification of 6 DARWINS and a 10% VaR per DARWIN, the risk of the account would round out at 2.4%, a value that would be considered excessively low compared to, for example, the median risk of the S&P (close to 4%)

Why therefore have we decided now to lower it to 10% with Risk Manager 2.0?

To change is to learn. During the last year , we have studied closely the behavioral changes of our users, and we have learnt that:
  1. The DARWIN providers have ( or can have) loss aversion
  2. An elevated risk in the DARWINS damages the positioning and the credibility of our market
  3. A higher risk of a DARWIN produces poor timing for the investors
  4. We can avoid that diversification reduces the risk of a portfolio excessively

Loss Aversion

During the last year, there have been cases in which the volatility of the DARWIN has generated changes in the trading models that the traders operate in their underlying strategies. Above all, the most conservative traders when it comes to risk management, have been affected psychologically by the higher DARWIN volatility, and have unconsciously modified their models, prejudicing the quality of the DARWIN, and consequentially their investors too.

This blog post on loss aversion is old but gold!

Market credibility

An elevated risk is not welcomed by qualified investors. Despite being completely distinct business models, on many occasions we have been compared to social trading platforms , which in most cases profit from their client´s losses (they have business models similar to those of the casinos)

Unfortunately, with a VAR of 20%, drawdowns of more than 30% are common, which can easily generate scepticism with regards to our ultimate goal of our users winning.

Paradoxically, the average investor prefers to make 50% with a drawdown of 15% than to win 100% with a drawdown of 30%. This is something that can be seen in the human psyche , but is not financially logical: from the strictly financial point of view , both investments are the same (in truth, the second option is better, as it generates a better return with less capital). Reducing the VAR to 10% a month , is , amongst other things, a bet to admit investors qualified in our markets, and thus will favour our traders.

Investors' risk and timing

In the same sense, and to our obvious disappointment, we have learnt that many investors commit the same errors that almost all those active in finance commit: they tend to buy when the DARWINS are at their highs, and to sell at the moment that they produce drawdowns, producing systematic losses ( which is aggravating as the DARWINS with good fundamentals tend to gain in the long term and to recover quickly after they fall.)

This phenomenon merits it´s very own post , in which we will compare data and recommended models from the moment of their investment in DARWINS. In whatever case, reducing the VAR by a half, we hope to minimise this “panic effect” in our investors, making it more bearable to maintain their investments during the falls in prices (inevitable in whichever financial instrument is chosen)

Diversification, profitability and risk

Diversification is, without doubt, recommended. To protect against the most unpredictable phenomena , such as the the “flash crash” in sterling on the 7th of October last year, diversification for protection against abnormal volatility spikes that our risk manager cannot prevent is vital.

That said, it is also certain that an excessive diversification results in less potential profitability. Accounts with more than 10 Darwins and a VAR of 10%, produce very reduced yields (the DARWIN investor does not characterise themselves as being very conservative). As the number of DARWINS increases , in our community we are experimenting with a growth in the size of the accounts, (and the quality of the DARWINS are also getting better). Because of this , we have devised a mechanism that will permit the investors to diversify without the need to relinquish profitability, but that is the subject matter of another post that we will write in the near future…It’s a surprise!!!

Lastly, we have no doubt that there will be users that will not be happy with the changes in risk, because they are happy with 20%. You cannot please all the people all the time. Or not?? To avoid dissatisfaction in Darwinex reloaded , we will introduce the possibility to use leverage on behalf of the investors , so that they can duplicate the leverage (and, in essence they can carry on investing at 20% of VAR).

Looking to the future, even though we are still in the conceptual phase, it is possible that we raise the available leverage factor as a function of the number of DARWINS in the account and their correlation ( although never more than a limit that we will settle on).

 

We leave it here , just the first few brush strokes of the new Risk Manager, and in following posts, we will explain in a more detailed form the other 3 changes mentioned in the introduction. As always we are always available for whatever you need on info@darwinex.com.

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:thumbsup:
Looking foward to :darwinex: reloaded. Hope to see changes on Timing Attribute as well because it is not favour for long term trader.

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The series looks very exciting, hoping that the episodes will not be too spaced in time :wink:

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I agree with you so much that I could almost accuse you of plagiarism :wink:

Seriously, it’s good to know that we are at least two to see the problems as they arise.

I would suggest two simple things:

• A lower threshold of the VaR of the strategy at 5% instead of 0.1%
• Restoring the choice of 3 levels of VaR on the investor side for the Darwin.

Simple things that would have an incredibly positive impact.

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This is a real paradoxe. Darwinex do not only “control the risk” like a real professional Hedge Fund algorithm Risk Manager would do.

  1. First of all, Darwinex boosts/adjusts our positons. So, Darwinex takes active decisions in the market while a real Risk Manager should only takes passive decisions. From the moment Darwinex manage the risk that way, it is Darwinex the trader. (People who gives their strategies can absolutely not be called ‘Traders’, in this case)

  2. Secondly, nobody can manage the risk better than the trader himself (I mean, a real trader). Only, gamblers crash their account when there is a big volatllity. At the opposite, the real trader will make its profit at this moment. The real trader is adapting himself to the volatility. But for Darwinex, the volatility is a bad thing when it come while for a real trader, volatility is best thing that can happen.

  3. Thirdly, Darwinex treats the negative and the positive excursions in the same way. In other words, Darwinex stop us when we are wrong (OK!) but prevents us to be right when we are right (KO!). (Maybe this 3rd point will change with the New RM)

Conclusion : 1) Darwinex is the trader. 2) Darwinex is afraid about volatility and 3) Darwinex do not let its profits run. One of the results is the DWEX.

There is an other way…

Dawinex just have to buy a normal professional Risk Management algorithm. That’s all. We don’t need more. We all know, Darwinex has to take care about the UK regulators… But if Darwinex knew how to actively manage the Risk, Darwinex would have build a Hedge Fund and earn millions. Only 1 person in 1 Million, on average, can do it. It is always the same game… Always the same game… Always the same game. Darwinex must let the traders be active and just be passive like in the Hedge Fund industry. Then, normally, we should have a real Darwinian Natural Selection.

Pure Pip Producer
https://twitter.com/PurePipProducer

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PS : If the FCA is able to let Darwinex manage the investors risk by using a “monthly VaR at 10%”, the FCA is aslo able to let Darwinex manage the investors risk by using a “monthly circuit-breaker at 10%”. Thus, under this FCA umbrella, real talented traders could come at Darwinex and grow. It is not the case at the moment because it seems that someone, in the Darwinex team, still wants to be a trader. Because of this, Darwinex only attract gamblers who create everyday some really stupid gambling strategies to put it in this system. It would be better (in order to create a win-win-win effect), that Darwinex behaves like a Hedge Fund owner who engage traders under its FCA umbrella to make them grow. It is exactly what real professional investors are looking for and it is also exactly what real talented traders, who do not have the means to pay a FCA regulation, are waiting for…

Pure Pip Producer
https://twitter.com/PurePipProducer

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My proposition (for the investor side) is to let the investor choose between 2 different models and not only between VaR 10 or VaR 20 (because it is exactly the same model).

  1. Your actual monthly VaR 10% risk management model (with the actual Randomness Replication)

and

  1. An automatic monthy circuit-breaker model at -10% (with a pure 1:1 Replication)

With these 2 interfaces Darwinex could have all the options (and not only one).

The actual option (which we see everyday the results) and the new one (a serious option for professional of investing).

If Darwinex don’t do it now, sooner or later, someone else will.

And it is this “someone esle” who will attract real undiscovered traders.

Pure Pip Producer
https://twitter.com/PurePipProducer

Thanks for your suggestion.

I am very sorry to hear you don’t like our current offering. I would recommend using a regular PAMM-service for 1:1 replication, we don’t plan to offer such a service tough.

Best,
Ignacio

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Don’t be! It is ME who is very sorry to see that your current offer is not adapted to professional investors… And to real traders, by the way! Those who let their profits run. Sabes?

Thank you. But if I would have the financial means to have a PAMM-service, do you think I would be on Darwinex?

That’s why you hit the wall of the reality. You are trapped in an insoluble problem. The trading problem. The structural trading problem. Only 1 person in 1 Million, on average, has the solution.

A very good Broker you are. A very good Asset Manager you are not —> DWEX

So, soon, a Risk Manager 3.0, then a Risk Manager 4.0, a Risk Manager 5.0 etc etc…

Welcome to the reality of trading…

You need help, I suggest you to commission an independent study from traders who have succeeded in their life. (Qualitative Traders, Biomimicry Traders…)

They will tell you the same thing as me.

Except that me, I tell you for free.

Your model (Asset Manager side) is not long-term profitable for the investors.

The reality is that from the moment someone decide to successfully manage the risk on the financial markets, he has better chance to become a neurosurgeon or president of its country.

The Darwins will continue to crash, the ones after the others, even with your RM 2.0. The reason is very simple. It is a structural reason :

You use the Bell Curve. The Bell Curve which everybody knows that is a wrong model. Even those who created it, admit it.

I told you what I had to tell you. You are warned.

Please, do not misunderstand me, if I tell you this truth, it is because I want you to succeed.

And I’m the only one here!

Pure Pip Producer
https://twitter.com/PurePipProducer

Thanks a lot for your feedback and your warnings, much appreciated.

We will keep working hard on our side to improve our services.

Best,
Ignacio

No need to work hard.

This is very simple.

Just create the conditions of the Life.

And the seeds will grow by themselves…

Pure Pip Producer
https://twitter.com/PurePipProducer

Expertly handled.

The phrase “this too shall pass” comes to mind :wink:

Taoinvestments

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what financial means? just go to alpari and start a pamm with 500$ it has all you mentioned you need. the also have about 20m investors money on the platform looking for home.

@ignacio Darwinex, keep up good work, great descision to keep 20% var option, darwins like mine are highly diversified alread and have strict risk control, Darwinex risk manager actually adds extra safe leverage to the algo for investors, compensating for reduced markets volatility

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It is true that the challenge of Darwinex is immense.

The staff sometimes have the impression of being football coaches obliged to listen to hundreds of fans explaining to them the correct way to do their work :wink:

And my example is too simplistic, because in the case of trading, everyone plays his own games according to his own rules.

It must not be forgotten that if it was so easy, it would have been a long time.

I do not forget that between my Mac Plus and my MacBook Pro Retina, there are 30 years of improvement. Darwinex enters its second year …

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Totally wrong. or, as you said, it is only ‘an impression’…

They don’t do their work. Do you know why? It is fundamental.

The promess of Darwinex was “to allow traders to trade and investors to back them” :

Investors can’t “back” the traders at the moment. They can only back the Darwinex Algorithm who is thinking that he knows better than the traders what will be the Future.

Yesterday, we had a proof again from a guy they interviewed few months ago (Darwin DCD) :

Who’s next?

I do not play my own game. I play our game. If you want to progress you must have the life development conditions. (That’s crazy that I have to explain this on a website which the name comes from Charles Darwin! :flushed:)

If you read correctly one of my previous post, you will read that I’m only talking about to create a WIN-WIN-WIN EFFECT.

Traders win, Investors win, Darwinex wins.

Read slowy to understand :

  1. If someone else manage actively the risk instead of you, you are not trader.

  2. To use Bell Curve (VaR) to manage the risk is like you want to put the world inside an equation. It never worked, it is not working, it will never work.

  3. If everybody here pretend to not understand that it is at the investor himself to choose his level of replication (1:1, 1:2, 1:3 or even 0.5:1, 0.25:1) it is because you want to be nice with the Darwinex Staff even though they are making a fundamental mistake on the road.

Conclusion : Keep your impressions for you. I’m talking about serious facts. Darwinex (Asset Manager) will be a bubble because of this kind of impressions. I’m right against all of you. Only a biomimicry incubator could make Darwinex great. And to have a Biomimicry space development, one of the possibilities of the replication should be at 1:1.

Pure Pip Producer
https://twitter.com/PurePipProducer

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Your diatribes prove instead that I am right :wink:

Each of us wants a Darwinex tailor-made for him.

And sometimes I myself am at the limits of schizophrenia. For example on my Darwin NEW I feel the risk increase by the system as a sabotage, but if tomorrow I have an AUM on my Darwin RSR, it will be thanks to this same phenomenon.

So we must recognize that we are not far from squaring the circle.

I’m not saying that the criticisms we make of Darwinex are wrong, I’m just saying that none of us, not even you, holds the absolute truth.

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:smile:

I rest my case.

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100% agree!
Maybe there are better models to manage risk that the bell curve, but there is margin of improvement also staying with this model.
I prefer an improved risk manager next month than a new unknown model next year.
While being penalized by the current risk manager, I have to say that for 90% of traders it is working quite well.

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@PurePipProducer
Your point of view is very interesting but this doesn’t mean all the others are wrong. :wink:

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Usually happy people don’t write about their happyness.
Probably the current 1.0 manager satisfies 90% of traders.
I think 2.0 will satisfy 95%.
When Darwinex will analyze live results of 2.0, they will start to think to a 3.0 that will satisfy 98% and so on…
Markets change, people change, traders change, investors change.
We keep adapting.

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