What is a Risk Score?
The Risk Score is a key feature offered by eToro that enables you to manage your total portfolio’s risk. It’s a numeric value, ranging from 0–10, where 10 is extremely high risk and 0 is extremely low risk. These numbers are not arbitrary – there is a thorough calculation behind them. You can find a detailed explanation of how it’s calculated below; however, for general reference, a score of 1–3 is considered low, 4–6 is medium, and 7–10 is high.
How is the Risk Score Calculated?
The basic idea is that every instrument has an average daily movement, which indicates its volatility. For example, let’s say the market price of instrument X shifts, on average, around 2% a day (i.e., during a given day, it will usually go up or down by around 2% from its price at the beginning of the day). This is basically its daily standard deviation, which is one of the key fundamental risk measures that analysts, portfolio managers, wealth management advisors, and financial planners use.
Statistically, if we multiply the average standard deviation by three, we create a range that will be correct 99% of the time. So, in our example, 99% of the time, instrument X will move up or down by a maximum of 6% in a single day.
The Risk Score is calculated using an algorithm that combines various factors. When calculating the Risk Score for an eToro investor, the algorithm also considers the following:
- The volatility of each instrument in that person’s portfolio
- The percentage of equity being invested in open positions: An investor putting a substantial amount of their equity in a single instrument or one asset class is considered a higher risk than a more diversified investor
- The direction of each position: If all of the positions in the portfolio are correlated with one another, the portfolio will be considered riskier than a portfolio that has a combination of short (sell) and long (buy) positions for the same asset
- The leverage used: Higher leverage means more exposure in the position, leading to more volatility and, therefore, more risk
The Risk Score for each investor is calculated daily and each investor’s average score is presented on their portfolio.