Presented at QuantCon Singapore 2016, Quantopian's quantitative finance and algorithmic trading conference, November 11th. Risk management is an essential but often overlooked prerequisite to success in trading. No one would like to see their substantial profits generated over his lifetime of trading just vanishing over a few bad trades. In this talk, Danielle will discuss a quantitative understanding of risk. She will then share a few techniques in risk management, with a case study to show how a proper risk management system helps improve the overall performance of trading strategies.

1. Build Effective Risk Management
on Top of Your Trading Strategy
© 2016 Hedga Technology. All Rights Reserved.
Presented by
Danielle Jiang, FRM
QuantCon SG 2016

2. A Quant Fanatic and A Game Changer
Danielle Jiang, FRM
1
© 2016 Hedga Technology. All Rights Reserved.
06 - 11
11 - 12
10
14 - 15
• Bachelor of Science in Quantitative Finance, First Class Honours
• Bachelor of Business Administration, Second Upper Class Honours
• GTO - Capital Market – Business Analyst
• Forex Exposure Management System
• Senior Business Consultant
• Commodity Repo Hedging, Receivable Finance Optimization
12 - 14
• Senior Quantitative Analyst
• Portfolio Risk Management, Portfolio Optimization, Performance Evaluation,
Back Testing, Stress Testing, Portfolio Simulation, Multi-Currency Hedging

3. The Smart Investment Decision Maker
About Hedga Technology
2
© 2016 Hedga Technology. All Rights Reserved.
Strategy Research and Development
We develop quantitative strategies for institutions to subscribe.
Consulting - Portfolio and Risk Management
We access risk and optimise portfolios based on advanced quantitative
models.
Robot Advisor
China-focused robot advisor with customisation.

4. The Mystery of Risk
A Different View from Quants
© 2016 Hedga Technology. All Rights Reserved.
Market Changes,
Your Risk Doesn’t
Build Risk Management

5. The Bias and The Truth
Why Risk Management?
1
© 2016 Hedga Technology. All Rights Reserved.
“Don’t tell me how to manage risk, tell me how to make money.”
“Opportunity can’t stand alone without Risk.”

6. The Bias and The Truth
Why Risk Management?
1
© 2016 Hedga Technology. All Rights Reserved.
“Risk management is boring. Profitable Strategy is exciting.”
“Risk management can make my strategy perform better.”

7. The Bias and The Truth
Why Risk Management?
1
© 2016 Hedga Technology. All Rights Reserved.
“Risk management is important…
only when the market is bad.”
“Risk management is important all the time.
It’s nothing to do with the market condition.
It’s all about you.”

8. The Bias and The Truth
Why Risk Management?
1
© 2016 Hedga Technology. All Rights Reserved.
“Risk managers do not know how to make money.”
“Well…We survive through the storm.”

9. The Mystery
What is Risk?
2
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Uncertainty
Fluctuation
Volatility
Unpredictable
Loss
Pain
Negative Impact
Disaster
Black Swan
Unknown
Instability
Over-LeveragedCrash
Drop
Holy Crap
Unexpected

10. A Recent Story
Do They Have the Same Risk?
3
© 2016 Hedga Technology. All Rights Reserved.

11. A Recent Story
Do They Have the Same Risk?
3
© 2016 Hedga Technology. All Rights Reserved.
Portfolio
No
YTD
Return
Mean
Return
Volatility
Downside
Volatility
Max
Drawdown
Sharpe
Ratio
Sortino
Ratio
Calmar
Ratio
1 3.86% 4.95% 2.61% 1.85% 1.88% 1.89 2.67 2.63
2 4.60% 5.88% 2.80% 1.97% 2.01% 2.10 2.98 2.92
3 5.08% 6.49% 3.10% 2.18% 2.27% 2.09 2.98 2.86
4 5.67% 7.22% 3.43% 2.41% 2.52% 2.10 2.99 2.86
5 6.25% 7.95% 3.76% 2.65% 2.78% 2.11 3.00 2.86
6 6.84% 8.68% 4.10% 2.88% 3.04% 2.12 3.01 2.86
7 7.42% 9.41% 4.43% 3.11% 3.39% 2.12 3.02 2.86
8 7.84% 9.92% 4.72% 3.32% 3.50% 2.10 2.99 2.83
9 8.17% 10.33% 5.00% 3.51% 3.68% 2.07 2.94 2.81
10 8.48% 10.72% 5.27% 3.70% 3.85% 2.03 2.90 2.78

12. Risk Analytics
How do we measure risk?
4
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Volatility?
@ http://www.businessinsider.sg/

13. Risk Analytics
How do we measure risk?
4
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Drawdown?

14. Risk Analytics
How do we measure risk?
4
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VaR?
CVaR?

15. The Mystery of Risk
A Different View from Quants
© 2016 Hedga Technology. All Rights Reserved.
Build Risk Management
Market Changes,
Your Risk Doesn’t

16. How about you?
The Three Views
1
© 2016 Hedga Technology. All Rights Reserved.
View 1: Reward is everything.
20% a year is absolutely better than 10%.
View 2: Separate View on Risk and Reward.
We look at ratios: Sharpe, Sortino, Calmar…
We compare risk-adjusted returns.
View 3: Return only is everything.
Return, as a random variable

17. as a random variable
Look at the Return ONLY
2
© 2016 Hedga Technology. All Rights Reserved.

18. Stochastic Dominance
How to compare?
3
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First order Stochastic Dominance
For any outcome x, A gives at least as high a probability of
receiving at least x as does B. For some x, A gives a higher probability
of receiving at least x.
Second-order Stochastic Dominance
A has a higher or equal mean and is more predictable than B

19. Stochastic Dominance
How to compare?
3
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First order Stochastic Dominance
Second-order Stochastic Dominance

20. Stochastic Dominance
How to compare?
3
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How about A & C?
They have different styles!

21. How to compare?
3
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Stochastic Dominance
They are similar in Style

22. The Mystery of Risk
A Different View from Quants
© 2016 Hedga Technology. All Rights Reserved.
Build Risk Management
Market Changes,
Your Risk Doesn’t

23. © 2016 Hedga Technology. All Rights Reserved.
The Steps
Build Risk Management
1
Step One:
Know Your
Strategy
Step Two:
Know Your
Preference
Step Three:
Know Your
Limit
Step Four:
Control
Trade Level
Risk

24. © 2016 Hedga Technology. All Rights Reserved.
It Has Personality
Step One: Know Your Strategy
1
A systematic trading strategy follows certain sets of rules
1. Market Entry Rules
2. Market Exit Rules
Statistics from Backtesting ( Use One Unit of Position Size)
1. Basics: Win Rate, Average Profit, Average Loss
Win Rate * Average Profit + (1 - Win Rate)* Average Loss
2. Advance: Fit the simulated trades to a distribution

25. © 2016 Hedga Technology. All Rights Reserved.
Step One: Know Your Strategy
1 It Has Personality
0
Strategy 1Strategy 2

26. © 2016 Hedga Technology. All Rights Reserved.
It Has Personality
Step One: Know Your Strategy
1
Two Different Strategies
Win Rate
Average
Profit
Average
Loss
Expected
Profit
Strategy 1 70% $50 -$30 $26
Strategy 2 30% $121.67 -$15 $26

27. © 2016 Hedga Technology. All Rights Reserved.
It Has Personality
Step One: Know Your Strategy
1
Assume Every Trade Signal is Independent
Make sure the probability for the worse case to happen is very
small.
e is a very small number,
n is the maximum losses you can have down the road in the
extreme case with a probability equals e

28. © 2016 Hedga Technology. All Rights Reserved.
It Has Personality
Step One: Know Your Strategy
1
Two Different Strategies
(e = 10^-6)
Win Rate
Average
Profit
Average
Loss
Expected
Profit
Worse Case
Losses
Strategy 1 70% $50 -$30 $26 12
Strategy 2 30% $121.67 -$15 $26 39

29. © 2016 Hedga Technology. All Rights Reserved.
People stays rational until the real thing starts
Are you patient enough when consecutive losses happen?
Are you sticking to the rule? (Yes, your algorithm does)
Do you feel greedy when consecutive wins happen?
Can you tolerance many losses?
Do you doubt about your strategy when it seems not performing?
Why preference matters? Trading is a process.
Your Psychology and Emotion Matters
Step Two: Know Your Preference
2

30. © 2016 Hedga Technology. All Rights Reserved.
Your Psychology and Emotion Matters
Step Two: Know Your Preference
2
Which One Do You Prefer?
Win Rate
Average
Profit
Average
Loss
Expected
Profit
Strategy 1 70% $50 -$30 $26
Strategy 2 30% $121.67 -$15 $26

31. © 2016 Hedga Technology. All Rights Reserved.
How much can you lose?
Step Three: Know Your Limit
3
Set a limit:
In worse case,
I can mostly lose 10% of my capital.

32. © 2016 Hedga Technology. All Rights Reserved.
Calculate how much risk you will take for every signal
Step Four: Control Trade Level Risk
4
Two Different Strategies
(e = 10^-6, RiskLimit = 10%, Capital = $100,000)
Win Rate
Average
Profit
Average
Loss
Expected
Profit
Worse Case
Losses
Loss Per
Trade
Strategy 1 70% $50 -$30 $26 12 -$874
Strategy 2 30% $121.67 -$15 $26 39 -$270

33. © 2016 Hedga Technology. All Rights Reserved.
Calculate how much risk you will take for every signal
Step Four: Control Trade Level Risk
4
Position Size is decided by Risk Management.
Derive the average position size: Strategy 1 = 29, Strategy 2 = 18
Win Rate
Average
Profit
Average
Loss
Expected
Profit
Worse Case
Losses
Loss Per
Trade
Strategy 1 70% $50 -$30 $26 12 -$874
Strategy 2 30% $121.67 -$15 $26 39 -$270

34. The Mystery of Risk
A Different View from Quants
© 2016 Hedga Technology. All Rights Reserved.
Market Changes,
Your Risk Doesn’t
Build Risk Management

35. Market Changes
Heteroskedasticity
1
© 2016 Hedga Technology. All Rights Reserved.

36. Not You
Market Affects Your Strategy
2
© 2016 Hedga Technology. All Rights Reserved.
Win Rate
Average
Profit
Average
Loss
Expected
Profit
Worse Case
Losses
Loss Per
Trade
Strategy 1 70% $50 -$30 $26 12 -$874
Strategy 1* 70% $100 -$60 $52 12 -$874
You should decrease your position size by 50%

37. Case Study
A Mean Reverting Strategy
3
© 2016 Hedga Technology. All Rights Reserved.
The General Idea:
1. Detect Abnormal Price Levels.
2. Go against the trend and take profit when the price is back to
mean.
3. Decide the stop loss price Level for the case of trend continuation

38. Case Study
A Mean Reverting Strategy
3
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Betting Same Lot Size

39. Case Study
A Mean Reverting Strategy
3
© 2016 Hedga Technology. All Rights Reserved.
Betting Different Lot Sizes, But Fix the Risk Exposure
The Average Lot Size here is the same as the previous case)

40. Case Study
A Mean Reverting Strategy
3
© 2016 Hedga Technology. All Rights Reserved.
Win Rate
Average
Profit
Average
Loss
Expected
Profit
Max
Drawdown
Profit
Factor
Fixed
Sizing
43.07% 2.81% 2.02% 0.0603% 32.05% 1.05
Floating
Sizing
43.07% 1.45% 0.97% 0.0723% 14.82% 1.13

41. In Hedga…
Extension
4
© 2016 Hedga Technology. All Rights Reserved.
1. Not just “Average Loss”, but how the loss distributed.
2. Think in Conditional Distributions. (Things may not be independent)
— use GARCH
3. Combine model and reality:
New limit = Original limit - Realised loss

42. The Full Picture
Extension
4
© 2016 Hedga Technology. All Rights Reserved.
1. Not just Average Loss, but how the loss distributed.
2. Think in Conditional Distributions, for time series.
3. Combine model and reality:
New limit = Original limit - Realised loss

43. Master Risk Management
The Ending
5
© 2016 Hedga Technology. All Rights Reserved.
Think in probabilities
A risk manager knows the chance of losing money, and how much it can lose…
he/she also knows the opposite.
The risk of going long is the opportunity of going short.
But wait, you got to be consistent.
Market Changes, You Don’t.

44. Q&A
© 2016 Hedga Technology. All Rights Reserved.