Essential risk management framework for all market conditions
| Strategy Type | Comprehensive Risk Quantification and Measurement Framework |
| Market Outlook | Essential risk management framework for all market conditions |
| Risk Profile | Risk measurement tool - quantifies and monitors all forms of trading risk |
| Reward Profile | Better risk management through precise measurement and monitoring |
| Time Horizon | Continuous monitoring with real-time and periodic calculations |
| Iv Environment | Adapts measurements to current volatility regime |
| Breakeven | N/A - measurement framework, not trading strategy |
| Market Risk Factors | S&P/TSX 60 VIX (VIXC) for Canadian market fear gauge • TSX heavily weighted in financials, energy, materials • CAD/USD exposure for US holdings • Bank of Canada rate sensitivity |
| Regulatory Context | Investment Industry Regulatory Organization requirements • Canadian margin requirements differ from US • Position limits on Canadian exchanges |
| Canadian Benchmarks | Bank of Canada overnight rate or T-bill rate • S&P/TSX Composite for beta calculations • VIXC for Canadian volatility |
| Tax Risk | 30-day wash sale rule affects tax-loss harvesting • Adjusted Cost Base crucial for capital gains • No longer restricted but FX risk applies |
Position Risk = Shares × (Entry - Stop). Example: 200 shares, $50 entry, $46 stop = 200 × $4 = $800. As a percentage: $800 / $50,000 portfolio = 1.6%.
Conservative: 6%. Moderate: 8%. Aggressive: 10%. In high volatility markets, reduce these limits. Heat above 10% means you're risking significant capital if all trades go wrong.
Position risk: before each trade. Portfolio heat: daily or when adding positions. Volatility and VaR: weekly. Full risk analysis: monthly. More frequently in volatile markets.
Personal limits vary, but common ranges: 15-20% for active traders, 10-15% for conservative traders. Set your limit, then size positions and manage heat to stay within it.
Concentration = Position Value / Portfolio Value × 100%. Example: $8,000 position / $50,000 portfolio = 16%. Keep single positions under 10% and sectors under 25-30%.
Historical method: Take your daily portfolio returns, sort them, find the 5th percentile (for 95% VaR). If portfolio is $100K and 5th percentile daily return is -2%, daily VaR = $2,000.
Historical VaR uses actual past returns - no distribution assumption but limited by history. Parametric VaR assumes normal distribution and uses mean/std dev - simple but understates fat tails.
Portfolio Beta = Σ(Weight × Position Beta). Find each position's beta (from financial sites or regress against market), multiply by portfolio weight, sum up. Example: 50% at beta 1.2 + 50% at beta 0.8 = 1.0.
In high volatility (VIX > 25), reduce limits: lower max heat from 8% to 5-6%, tighter position limits. In low volatility (VIX < 15), can use normal limits. Volatility regime determines appropriate risk.
Track correlations between your largest positions and between sectors. Build a correlation matrix. Positions with correlation > 0.7 should be treated as partly the same bet for risk purposes.
1) Model return distribution (normal, t, or other). 2) Create correlation matrix. 3) Generate correlated random returns (Cholesky decomposition). 4) Calculate portfolio value for 10,000+ scenarios. 5) Find percentile for VaR.
Key metrics: Position / ADV ratio (days to exit), bid-ask spread (exit cost), Amihud ratio (price impact). For L-VaR, add liquidation cost to standard VaR. Stress test assuming liquidity drops 80%.
A coherent risk measure satisfies four properties: monotonicity, sub-additivity, positive homogeneity, translation invariance. VaR is not sub-additive (diversification can increase VaR in edge cases). CVaR/ES is coherent.
Component VaR = Weight × Marginal VaR = Weight × (∂VaR/∂Weight). Sum of component VaRs = total VaR. Shows each position's contribution to total risk. Useful for risk budgeting.
In stress, correlations typically spike toward 1. Model correlation breakdown: assume correlations increase to 0.8-0.9 in stress scenarios. This shows reduced diversification benefit when most needed.
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