crypto_trader/docs/architecture/risk_management.md

Risk Management Architecture

Overview

The risk management system provides comprehensive risk control mechanisms including position sizing, stop-loss management, drawdown limits, Value at Risk (VaR) calculation, and portfolio correlation analysis.

Components

Position Sizing

Location: src/risk/position_sizing.py

Methods:

• Standard Position Sizing: Percentage-based with fee accounting
• Kelly Criterion: Optimal position sizing with fractional Kelly (configurable)
• Volatility-Adjusted: ATR-based position sizing (lower vol = larger positions)
• Regime-Aware: Adjusts position size based on market regime
• Confidence-Based: ML model confidence-adjusted position sizing

Usage:

from src.risk.position_sizing import PositionSizingManager

sizer = PositionSizingManager()

# Standard sizing
quantity = sizer.calculate_size(symbol, price, balance, risk_percent)

# Kelly Criterion (fractional)
kelly_pct = sizer.calculate_kelly_criterion(win_rate=0.6, avg_win=100, avg_loss=50, fractional=0.25)

# Volatility-adjusted
quantity = sizer.calculate_volatility_adjusted_size(symbol, price, balance, volatility_multiplier=0.8)

# Regime-aware
quantity = sizer.calculate_regime_aware_size(symbol, price, balance, market_regime="trending_up")

Value at Risk (VaR)

Location: src/risk/var_calculator.py

Methods:

1. Historical VaR: Uses historical portfolio returns distribution
2. Parametric VaR: Assumes normal distribution (variance-covariance method)
3. Monte Carlo VaR: Simulates future returns using estimated parameters
4. Conditional VaR (CVaR): Expected loss given that loss exceeds VaR

Usage:

from src.risk.var_calculator import get_var_calculator

var_calc = get_var_calculator()

# Calculate all methods
results = await var_calc.calculate_all_var_methods(
    portfolio_value=Decimal("10000.0"),
    confidence_level=0.95,
    holding_period_days=1
)

# Individual methods
historical_var = await var_calc.calculate_historical_var(...)
parametric_var = await var_calc.calculate_parametric_var(...)
monte_carlo_var = await var_calc.calculate_monte_carlo_var(...)
cvar = await var_calc.calculate_cvar(...)

Portfolio Correlation Analysis

Location: src/portfolio/correlation_analyzer.py

Features:

• Correlation matrix calculation for portfolio symbols
• Diversification scoring (lower correlation = better)
• Concentration risk analysis
• Correlation-based position limits

Usage:

from src.portfolio.correlation_analyzer import get_correlation_analyzer

analyzer = get_correlation_analyzer()

# Analyze current portfolio
analysis = await analyzer.analyze_portfolio_correlation(paper_trading=True)

# Check correlation limits before adding position
allowed, reason = await analyzer.check_correlation_limits(
    symbol="ETH/USD",
    new_position_value=Decimal("1000.0"),
    max_correlation=0.8
)

Stop-Loss Management

Location: src/risk/stop_loss.py

Provides dynamic stop-loss adjustment and management.

Risk Limits

Location: src/risk/limits.py

Manages:

• Daily loss limits
• Maximum drawdown limits
• Portfolio allocation limits

Risk Manager

Location: src/risk/manager.py

Orchestrates all risk management components and provides unified risk checking interface.

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