GuShiio.com If you read #8 and your reaction is “Haha, I’m not going to do that,” then chances are you need to cut your risk by 1/3 immediately.
Author:goodalexander
Compiled by: Shenchao TechFlow
Lesson 1: Understand the maximum retracement of your total portfolio
The first step in managing risk is to fully understand the maximum drawdowns that your portfolio may face. Specifically, it is recommended to sort out all your investment exposures, convert them into a total return series, and analyze the retracement situation in the following dimensions:
A. Maximum retracement from high to low (Peak to Trough Drawdown).
B. The extent of retracements in a single trade, especially Session Level Drawdown (Overnight retracements are particularly important in equity investments because you can’t sell at night).
C. Daily Drawdown.
D. Monthly Drawdown.
When conducting these analyses, do not consider any specific market factors and remain neutral.
It is recommended to analyze retracement data for the past one year and the past 10 years separately. However, there may be tools in your portfolio that lack 10 years of historical price data. This can be solved by establishing a revenue matrix and selecting an agent tool. For example, for a tool with a shorter history like Hyperliquid, you can choose XRP as the proxy tool because its historical data dates back to 2015.
When investing or trading, an important question is:Is there a possibility that the loss will exceed the expected range? You need to assume that actual market fluctuations may exceed your simulations, because markets tend to break through the limits of historical data.
Maximum pullback = Max (3 times the maximum loss of the past year, 1.5 times the maximum loss of the past 10 years).
Another important caveat: When calculating these retracements, you need to remove your strategic advantages and only calculate losses from the tool itself, not losses based on retracements.
A key measure of the effectiveness of risk management is the percentage of monthly earnings as a percentage of the maximum retracement. In contrast, the Sharpe Ratio is not a suitable measure of actual risk because it cannot reflect real scenarios (such as whether you will collapse because of a huge loss and switch to accounting).
Lesson 2: Understand your key market Beta exposure
In risk management, it is crucial to understand the relevance of your portfolio to the market (i.e., Beta exposure). Here are some typical market Beta exposure categories:
Traditional Financial Markets (TradFi):
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Standard & Poor’s 500 Index (S P 500, code: SPY)
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Russell 2000 Index (code: IWM)
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Nasdaq Index (Nasdaq, code: QQQ)
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Crude oil (Oil, code: USO)
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Gold (code: GLD)
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China Market Index (Code: FXI)
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European Market Index (code: VGK)
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Dollar Index (code: DXY)
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Treasury bonds (code: IEF)
Cryptocurrency market (Crypto):
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Ethereum (ETH)
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Bitcoin (BTC)
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Top 50 altcoins (excluding ETH and BTC)
Most investment strategies do not have explicit market timing strategies for Beta exposures in these markets. Therefore, these risks should be minimized to zero. Generally, the most effective approach is to use futures instruments because they have lower financing costs and require less balance sheet requirements.
Simple rule: Understand all your risks clearly. If there are uncertain risks, try to avoid them by hedging.
Lesson 3: Understand your key factor exposure
In investing, factor exposure refers to the extent to which your portfolio is influenced by certain market-specific factors. Here are some common factor exposures:
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Kinetic energy factor (Momentum):Pay attention to price trends, buy rising assets and sell falling assets.
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Value factor (Value):Invest in undervalued assets, such as stocks with low P/E ratios.
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Growth factor (Growth):Invest in assets with rapid growth in revenue or earnings.
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Carry factor:Invest in high-yield assets through low-cost financing.
These factors are difficult to capture in actual operations. For example, you can use an ETF (such as MTUM) to capture the momentum factor of the S & P 500, but in fact this means that your strategy may tend to chase gains and kill losses. This is particularly complicated because in trend strategies, you may deliberately take on certain factors of risk.
Some effective measures of factor exposure include:
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The average price Z-score for the non-trend strategy component (a measure of the relative position of prices).
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Average P/E ratio (or equivalent) for the non-value strategy component.
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Average revenue growth rate (or expense growth rate) for the non-growth strategy component.
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The average return on your portfolio (if your return is in the mid-double digit range, it may mean you are taking on a higher carry factor risk).
In the cryptocurrency market, trend factors often fail as the overall market fluctuates, because too many investors use similar strategies, causing potential risks to be amplified. In the foreign exchange market, yield strategies (such as carry trading) have similar problems. The higher the yield, the greater the potential risk.
Lesson 4: Adjust position size based on implied volatility, or set clear position size parameters for different market environments
In risk management, using Implied Volatility rather than Realized Volatility to adjust position sizes can better cope with market uncertainty. For example, when earnings reports are released or elections are approaching, implied volatility tends to more accurately reflect market expectations.
A simple adjustment formula is: (implied volatility/real volatility over the past 12 months)&www.gushiio.coms; maximum retracement in the past 3 years = assumed maximum retracement for each instrument
Based on this formula, a clear maximum pullback limit is set for each tool. If an instrument lacks implied volatility data, it may mean that it is illiquid, which requires special attention.
Lesson 5: Be wary of the cost impact caused by insufficient liquidity (liquidity risk)
In less liquid markets, transaction costs may increase significantly. A basic rule: Never assume that you can sell more than 1% of your daily volume in one day without having a significant impact on prices.
If the market becomes illiquid, it may take days to clear your position completely. For example, if you hold a position that accounts for 10% of the day’s volume, it may take 10 days to clear. To avoid this situation, it is recommended to avoid holding positions that exceed 1% of daily trading volume. If this ratio has to be exceeded, when modeling the maximum loss, it is recommended to assume that the risk doubles for every 1% increase in the maximum pullback of the tool (although it may seem conservative, this assumption is very important in practice).
Lesson 6: Identify the only risk that may cause me to collapse and conduct qualitative risk management
Although the above methods are mainly quantitative analysis, risk management also requires qualitative and forward-looking judgment. At any time, our portfolio may face hidden factor exposures. For example, investors who now hold long positions in USDCAD may face risks related to Trump’s tariffs. Such risks are often not captured through historical volatility because news events change too quickly.
A good risk management habit is to regularly ask yourself: What is the only thing that could break me down? rdquo;
If you find that you hold positions that are not related to certain potential risks, such as the connection between a USDCAD position and Trump tariffs, consider hedging these risks through relative value transactions (such as investing in Mexican stocks rather than U.S. stocks).
In fact, most historically significant losses are not particularly surprising over a multi-week horizon. For example, during the Taper Tantrum period, markets were already aware of possible problems with interest-rate sensitive assets. Similarly, many signs were already emerging before the COVID risk broke out. By identifying these risks in advance, you can better protect your portfolio.
Lesson 7: Clarify your risk limits in advance in the risk framework
Before making any investments or bets, it is important to clarify the following key issues in advance:
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What is the specific content of the bet? You need to be clear about the core logic and goals of the deal.
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How much loss are you willing to bear? Set an acceptable loss range in advance to avoid emotional decision-making.
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How to reduce market exposure? If the market goes against the market, do you have enough strategies to control the risk?
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Can I exit the transaction in time? If a trade goes against you, can you close your position quickly? Do I need to reduce the size of my position in advance?
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What’s the worst-case scenario? Identify risk factors that may lead to significant losses and prepare for them.
Keeping a record of the answers to these questions, or continuing to track them in some way, can help you manage risks more clearly.
Lesson 8: Reflecting on your own risk management performance
In risk management, maintaining a clear understanding of your performance is crucial. If your reaction when you read this is haha, I’m not going to do this or what does this have to do with ordering Wendy’s burger, then chances are you need to cut 1/3 of the risk immediately or shouldn’t have taken those risks in the first place.
Keep in mind that Wendy’s menu is cheap and simple. If you think of the market as Wendy’s, then your position size should also be kept low risk, rather than making extravagant bets like a visit to the Ritz Hotel.
Of course, I also know that most people will not follow these suggestions completely. I fully understand that publishing this content may be futile, so you don’t need to remind me of this anymore.
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