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A Monte Carlo simulation randomly generates values for uncertain variables
over and over to simulate your trading model. It's like using multiple
"what-if" scenarios in each of which random numbers (for example
hypothetical P/L of each trade) are generated by the program to test the
consequences on your equity.
Suppose you have a system that has generated 100 trades with 63%
profitability, $210 average win and $150 average loss (actually you may use
much more than this information). Although these numbers show a positive
expectation, you still want to know the probability of ruin in case things
go south. For example it is possible that the next 100 trades will not have
the same profitability; but even if they do, there is still the danger of
greater than the expected drawdown due to large and unexpected streaks of
consecutive losers. In the worst scenario your capital is gone before you
had the chance to recover.
So, what you need is to feed the simulator with your stats and let it make
thousands of trials of 100 trades each, in order to see in how many - if in
any - of these trials the worst scenario has occurred indeed. Actually you
need to know more than just the probability of ruin: you want to compare
your system's results with those randomly produced by the simulator, study
minima and maxima, drawdown, average trade, equity curves etc.
I use Excel, because thanks to VBA I am able to adjust the simulation
according to my needs. Monte Carlo simulation is quite useful in the sense
that you have the chance to correct a few things before you start trading in
the real market and at least get prepared for various scenarios, either good
or bad. It's not the holy grail of course and there has been criticism about
it but I still think it is useful. You can find more on the Web.
Spyros
Message: 4
Date: Mon, 08 Dec 2003 10:43:11 -0000
From: "metastockuser" <metastockuser@xxxxxxxxx>
Subject: Monte Carlo Simulator....anyone here use one?
I understand that a Monte Carlo Simulator might help in system
development.
I was curious as to whether anyone here uses a monte carlo simulator
in their trading development and exactly what value they feel it adds
to the process?
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