Monte Carlo Simulations
Sounds tough right, sounds fancy!!
It is a tool to stress test your investment strategy in different “universes”. Seems weird. Don’t worry it will all make sense in some time.
The concept of “different universe” is an exciting read and is driven by philosophy.
It states that different versions of you exist simultaneously in a parallel domain.
For example, in one universe, you are a software engineer, in other, you are a Broker.
A Monte Carlo simulation is used after backtesting a strategy having good result metrics.
It is a tool to test the robustness of the strategy in different environments
Hundreds and Thousands of new mathematically generated samples replace the actual stock data to a form in which it might exist in a different universe.
This is the data no one has seen till now and you can simulate on a thousand samples of it.
By our knowledge, it is one of the most sophisticated tools for risk management in today’s time. Once a strategy has been backtested on multiple stocks, and Monte Carlo simulations have given good results, the next important step is to create an optimized portfolio, i.e. develop a collection of stocks such that the money is distributed to each stock in the most optimized manner.
