Risk Simulation: What can you expect from your Trading System?

A Monte Carlo simulation projects your trading system’s equity curve into the future. You only have to know the average loss, average win and hitrate of your system.

Because I could not find a good monte carlo simulation tool in the internet, I created my own Risk Simulator and made it free for everyone.

The simulation can get you a realistic sense of the inherent risks in your trading system. Moreover, it shows what you can expect on average in percentages or R Multiples.

Hint: If you have recorded a significant amount of trades (~70) from your trading system, you can use file as input to use your own trading history and let the simulator calculate hitrate, weighted average win/loss and standard deviations of wins/losses of your system automatically as a basis of the monte carlo simulation.

Looking at the cumulative probabilities of drawdown and returns you can know what to expect on average from your trading system and how high the probabilities of each outcome are.

Furthermore, the return distribution shows you how much your winning or losing trades are bouncing around, based on standard deviation.

That’s not all, there’s more to it.

Expected Drawdown

Different to the highest relative drawdow, this is the drawdown you can expect to have some day in the future. It has a 1% probability of occuring when taking a certain number of trades.

Profit Factor / Expectancy / Sharp Ratio

These numbers show you how well your system is managing risk. On top of that, it lets you compare different trading systems with each other. Higher readings are better.

The sharp ratio makes it possible to compare your return, relative to the volatility of your system, to benchmarks such as bonds or stock indices.

Drawdown Allowance

In the “DD Allowance” field of the Risk Simulator you can specify which drawdown you accept as the highest drawdown. If you run the simulation again, it will show you suggestions on how to not reach this drawdown.

Absolute Drawdown

An absolute drawdown is the drawdown directly counting from the starting capital.

There’s a highest absolute drawdown from all simulation runs and an average one. Why is the average absolute drawdown so low? This is because the chance of reaching your highest drawdown directly in the beginning is relatively low.

Consider the fact that more trades lead to a higher probability of your maximum drawdown occuring.

How does a Risk Simulation help you?

The statistics can’t lie. A Risk Simulation helps you to understand the statistics of any trading strategy.

Knowing the expected drawdowns can help you to find the correct position size for your trading system. A position size that makes it highly impossible to get in a drawdown, that kills your profitability.

On the other hand, knowing what you can probably expect from your trading style can stop too much “hoping around”. It defines how much capital you actually need to reach your goals while keeping the risk aligned with reality.

Position Size, Risk in Trading

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Who I am

My name is Niclas, I day trade futures since 6 years.

Leveraged products offer a high risk exposure and 95% of people don't understand the real risks in trading them.

I teach traders how to understand risk on a professional level. Moreover, I created the Risk Simulator to give the trader community a tool, that is useful for anyone who trades a trading system.

If you want to improve your risk management skills and learn more about trading. Visit my courses or read articles in my blog section.

Risk Disclaimer

Before buying or selling any kind of derivatives, you should carefully review the rules and regulations of the exchanges offering the system and/or listing the instruments you intend to trade. Trading has inherent risk due to system response and access times that may vary due to market conditions, system performance, and other factors. You should understand these and additional risks before trading. None of the information provided on this website constitutes a solicitation to trade any investment or security of any kind. Read the full Risk Disclaimer.

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