05. Scenario Analysis

Discussing Trading Strategy Testing and Simulation

Testing a trading strategy requires exploring both historical and potential future stock price developments. Here's how to effectively evaluate a strategy:

Key Aspects

• Historical Testing

  • Uses past stock prices to observe how the strategy performs in already occurred scenarios.
  • Provides insights into past performance but may not capture future variations due to stochastic nature of prices.

• Scenario Analysis with Simulations

  • Implements the GBM (Geometric Brownian Motion) method to simulate multiple price trajectories.
  • Allows testing against various potential future price paths with varying growth and stagnation phases.
  • Requires predefined parameters: Mu (growth rate) and Sigma (volatility).

How Simulations Assist

• Simulated trajectories divided into two phases: strong growth and stagnation.
• Back testing involves calculating performance metrics like the Sharpe Ratio and maximum drawdown.
• Provides a broader understanding of strategy adaptation to potential market behaviors.

This approach builds comprehensive insights into the robustness and adaptability of trading strategies to expected and unexpected price movements.