The Monte Carlo method for strategy analyses

Quantitative trading is all about the assessment of probabilities and using these in your favor. In order to collect these probabilities and consider multiple scenarios for risk management purposes, there is a great statistical technique available to use.

Trading is all about probabilities. What are the chances that your next trade is going to be a winning trade? Over the next 1000 trades, what is the maximum drawdown you can encounter given the statistics of your strategy? These questions are essential for traders and investors because they help to shape the expectations and risk management approach for the strategy.

In order to assess probabilities, you need to have a large sample size of the data you are analyzing. In our case, this data is the outcome of trades that fit our strategy. However, if you collect data on your strategy through backtesting, manual or automatic, you can only collect data that falls within your sample. What you actually want to know is how your strategy performs under several scenarios taking into account random variables.

A Monte Carlo simulation is a statistical tool that can generate random scenarios for your in-sample data. In simple terms, a Monte Carlo simulation can repeat random samples of your data thousands of times to generate different potential outcomes. Using this method you can assess how resilient your strategy is to randomness in certain variables.

The Quant Analyzer software gives you the ability to generate simplified Monte Carlo simulations on your Metatrader reports. It’s an accessible way to assess the robustness of your reports.

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Kind regards,

Joost