book-tac/book/chapters/10-risk-limits.md

Chapter 10 — Risk Limits That Work

Status: drafting. Claim inventory: see README.md ch. 10. HITL review gate applies: risk-limit advice.

Risk limits gate the live book before execution: a liquidity floor, a size cap, a concentration cap, and a drawdown pause. This chapter is deliberately careful about what it claims: the A/B evidence that the liquidity floor beats concentration caps is a pre-reset idea (not comparable post-reset); what is PROVEN is that the spec executed in round 3 and the funnel held. Any desk acting on the A/B numbers is acting on a hypothesis until the post-reset rerun lands.

The spec as executed

Round 3 ran with risk_limits: liquidity floor $5M (min 20-day average dollar volume), size cap 12% of book per name, concentration cap 95%, drawdown pause 10% (pause new buys if equity ≤ 90% of peak) (PROVEN → round 3, EVIDENCE#020). The gates acted: the liquidity floor dropped 8 names from the target list before placement, and one further name was skipped at decision time (SLV, delta_zero) — the funnel closed 10 → 10 → 10 → 9 (PROVEN → round 3 funnel, EVIDENCE#020).

Two facts stand out. First, the liquidity floor was the active gate — it removed 8 of 10 low-liquidity ETF names, which is exactly the gate's purpose on a panel of thinly-traded funds. Second, the drawdown-pause gate did not trip (equity stayed above the pause threshold), so this round is not evidence about the pause's behavior — only about its non-interference.

What is PROVEN vs what is idea material

• PROVEN (execution): the risk-limit spec runs, gates, and does not break the funnel — round 3 (EVIDENCE#020).
• HYPOTHESIS (idea, pre-clean-lake): the A/B that the $5M floor improves the book — net IR 0.81→0.98 and drawdown 7.9%→5.4% in exp 18 — and that size/concentration caps hurt by cutting deployed capital (IR 0.816) (idea → exp 18, EVIDENCE#008; not comparable post-reset, exp 20 R0 note). These are exactly the numbers the book must NOT cite as fact.
• HYPOTHESIS (idea, pre-clean-lake): entry/risk gates (momentum, HMM regime) were byte-identical no-ops in exp 20, supporting "the signal is the bottleneck, not the risk layer" (idea → exp 20, EVIDENCE#009).

TODO(evidence-needed: risk-limit A/B on the post-reset reference — rd_risk_calibrate on the exp-26 lineage, comparing floor-on vs floor-off and the cap grid)

Design guidance (derived, hedged)

Reading across the (pre-reset, idea-tier) A/B and the (clean, proven) execution, the book offers hedged guidance — each item marked for what it is:

1. Liquidity floor first. It was the only gate that acted in round 3, and it removes names the book cannot actually trade at size. HYPOTHESIS that it is the highest-value limit (pre-reset A/B + round-3 execution consistent, not a clean A/B).
2. Caps that cut deployed capital cost edge. On a thin-cost book, a size cap that forces smaller positions than the strategy wants spends the exact budget ch. 09 says is binding. HYPOTHESIS (idea-tier evidence, mechanism consistent with exp 26).
3. Gates are no-ops when the signal is weak. A regime/momentum gate that rarely trips adds complexity, not protection. HYPOTHESIS (idea-tier evidence).
4. Pause gates are for tail events. The drawdown pause is untested in round 3; it is cheap insurance, and its behavior under stress is unknown. HYPOTHESIS.

Where risk limits sit in the loop

Risk limits are a post-signal gate — they cannot create edge, they can only destroy or preserve it (ch. 02). The campaign's reading is that the signal is the bottleneck (exp 20 idea, consistent with the clean-lake cost finding of ch. 09): limits should remove untradeable names and stop the book from self-destructing in a drawdown, and otherwise stay out of the way. That is a working posture, not a proof.

Practice note

Run limits as a pre-gate on the same spec that gates backtests (rd_backtest/rd_strategy_targets share the risk_limits spec, so backtest and live are gated identically — the setup the campaign used). Reconcile each round's gate actions (names dropped, pauses tripped) in the trail (ch. 11). Until the post-reset A/B lands, treat the floor's benefit as hypothesis and the spec's execution as fact.

Open questions

• TODO(evidence-needed: post-reset risk-limit A/B on the exp-26 lineage)
• TODO(evidence-needed: drawdown-pause behavior — it never tripped; no evidence on its trigger/recovery)
• TODO(evidence-needed: liquidity floor level sensitivity — is $5M the right cutoff on this panel?)