crypto_trader/docs/architecture/risk_management.md

Risk Management Architecture

This document describes the risk management system.

Risk Management Components

Risk Manager
    ├──► Pre-Trade Checks
    │         │
    │         ├──► Position Sizing
    │         ├──► Daily Loss Limit
    │         └──► Portfolio Allocation
    │
    ├──► Real-Time Monitoring
    │         │
    │         ├──► Drawdown Monitoring
    │         ├──► Position Monitoring
    │         └──► Portfolio Monitoring
    │
    └──► Stop Loss Management
            │
            ├──► Stop Loss Orders
            └──► Trailing Stops

Pre-Trade Risk Checks

Before executing any trade:

1. Position Sizing Check

   • Verify position size within limits
   • Check portfolio allocation
   • Validate against risk parameters

2. Daily Loss Limit Check

   • Calculate current daily P&L
   • Compare against daily loss limit
   • Block trades if limit exceeded

3. Drawdown Check

   • Calculate current drawdown
   • Compare against max drawdown limit
   • Block trades if limit exceeded

4. Portfolio Allocation Check

   • Verify total exposure within limits
   • Check per-asset allocation
   • Validate diversification requirements

Position Sizing Methods

Fixed Percentage

position_size = capital * percentage

Kelly Criterion

f = (bp - q) / b
position_size = capital * f

Volatility-Based

position_size = (capital * risk_percentage) / (stop_loss_distance * price)

Risk Limits

Configurable limits:

• Max Drawdown: Maximum allowed drawdown percentage
• Daily Loss Limit: Maximum daily loss percentage
• Position Size Limit: Maximum position value
• Portfolio Exposure: Maximum portfolio exposure percentage

Stop Loss Management

Stop Loss Types

• Fixed Stop Loss: Fixed price level
• Trailing Stop: Adjusts with price movement
  • Percentage-based: Adjusts by fixed percentage
  • ATR-based: Adjusts based on volatility (Average True Range)
• Percentage Stop: Percentage below entry
• ATR-based Stop: Based on Average True Range (volatility-adjusted)
  • Automatically calculates stop distance using ATR multiplier
  • Adapts to market volatility conditions
  • Configurable ATR period (default: 14) and multiplier (default: 2.0)
  • Works with both fixed and trailing stops

ATR-Based Dynamic Stops

ATR-based stops provide better risk management in volatile markets:

stop_loss_manager.set_stop_loss(
    position_id=1,
    stop_price=entry_price,
    use_atr=True,
    atr_multiplier=Decimal('2.0'),
    atr_period=14,
    ohlcv_data=market_data,
    trailing=True
)

Benefits:

• Adapts to market volatility
• Tighter stops in low volatility, wider in high volatility
• Reduces stop-outs during normal market noise
• Better risk-adjusted returns

Calculation:

• Stop distance = ATR × multiplier
• For long positions: stop_price = entry_price - (ATR × multiplier)
• For short positions: stop_price = entry_price + (ATR × multiplier)

Stop Loss Execution

Price Update
    │
    ▼
Stop Loss Check
    │
    ├──► Stop Loss Triggered?
    │         │
    │         └──► Execute Market Sell
    │
    └──► Update Trailing Stop (if applicable)

Real-Time Monitoring

Continuous monitoring of:

• Portfolio value
• Unrealized P&L
• Drawdown levels
• Position sizes
• Risk metrics

Risk Alerts

Automatic alerts for:

• Drawdown threshold exceeded
• Daily loss limit reached
• Position size exceeded
• Portfolio exposure exceeded

Integration Points

Risk management integrates with:

• Trading Engine: Pre-trade validation
• Order Manager: Position tracking
• Portfolio Tracker: Real-time monitoring
• Alert System: Risk alerts