What number are YOU? eToro Risk score explained
eToro Risk score management
Here are some of the ins and outs of the system that all those in the Popular investor program live and die by... but that most not knowing what it consists of.
The exact eToro formula is a little bit of a mystery as its not expressed in its entirety on any of the pages that I have found on the eToro website. However there is a very useful link to a Wiki page (VaR).
Please bear in mind that any of the conclusions that I draw are from my own personal experience with eToro and what knowledge I had prior to eToro and is not quoted from eToro or their employees unless stated.
What is the Risk System?
The risk system with-in eToro is based on the VaR (Value at Risk), It is basically an estimation of Losses given 'normal' market conditions and given that no new positions are created or closed.
It is actually mainly used by financial firms and regulators to estimate the needed amount of funds to cover any expected losses.
VaR typically has four main uses, Finance (risk management), financial control, financial reporting and for regulatory capital. At eToro with-in their PI program it is mainly used in risk management and risk mitigation. To prevent copiers from allocating funds to some one that is trading with a too high a risk mentality. As this could cost Copier and Copied accounts to both have sweeping losses.
As far as my understanding goes at this point, eToro uses approximately 3hr/6hr calculation cycle as stocks and cryptos move affecting the overall profile. So that there is a more consistent benchmark.
Are there some sectors that have higher risk?
YES! As many of us have found out as soon as they start trading Crypto-currencies their Risk score very quickly starts to climb.
This is down to the volatility of each instrument and each crypto is seen as highly volatile. Where as at the moment the financial sector in the US (ie. Banks) are carrying a relatively low risk score. The Tech sector is the middle of the road after their recent fall from grace. PLEASE NOTE These are subject to change on a regular basis as the algorithm is continuously morphing.
Why has my risk score gone up even though I haven't opened any new positions?
There are a multitude of reasons, however I have found personally that unrealised profits are mainly to blame.
E.g. You opened a trade of Ethereum at $100 with a value of $250.
Over time the value of Ethereum climbs to $200.
Your value of trade is now $500.
But the equity at risk is not just the $250 you opened the trade with but also the extra profit that is un-realised (still in a trade and not cashed out) so the total at risk is $500.
Another reason is that as a value of a certain instrument (position of one stock/currency) raises, It distorts your portfolio so that the algorithm sees that you are risking more of your equity in one place meaning any movement would effect your assets greatly.
E.g. You have a total of $500 in your account.
You open an Ethereum position of $250.
Ethereum doubles in price and the value of the position is $500
Of your total equity ($750) £500 is invested in one instrument. Meaning that you have 66% of your investment in one Currency and very exposed to potential losses.
What is the maximum risk score I can be copied with?
The maximum Risk score you can be copied with on eToro is 6. Any score above this activates an assessment period that is determined on a case by case basis.
Where can I find my Risk data?
With in the eToro portfolio tab there are different views. One of these is a pie chart section, you will need to select the 'Risk' button and then it will give you a break down of what your most risky assets are.
How to keep my risk score low
As the old saying goes 'There are many ways to skin a cat' (I really do hope that saying is known worldwide and translates correctly...)
The simplest way is 'water down' your risk by adding more funds to your account to increase your available balance. This isn't always possible and is really more of a short term quick fix instead of a real solution.
The better ways are;
Diversify more -do this only in markets that you are comfortable trading in, trading in an area of the market you are unfamiliar with or have no experience with is very dangerous!- the more different sectors that you are invested in the less likely you are to be caught out by any big corrections in any particular sector.
Use less/no leverage, leverage is THE best way to increase your risk if you ever wanted to. I personally use very small amounts of leverage. In my holdings of stocks there is virtually no leverage.
Hedging is also another way that you can reduce your risk score. BUT NOTE using this technique too much will cost you funds and it does require a lot of concentration and skill, I will be writing up another article on this matter as a stand alone article.
Last but not least, close some of your trades. It will be a two way benefit, less invested funds and more available equity.
Hope you have enjoyed reading this and it has shed some light on the infamous eToro Risk score.