The Art of Simulation

The ability to simulate the performance of a trading strategy back through time is one of the key benefits of a systematic approach to investing. However, it is vital that it is performed in a scientific and disciplined manner. Simulation allows us to test an investment strategy on a range of markets and market environments. At its best it enables a scientific approach to investment research where hypotheses can be tested and strategies can be designed, with the aim of assessing a given approach to trading the markets. However, building a strategy which shows a profitable simulation is deceptively easy, while building a profitable portfolio is considerably more difficult. There are many potential pitfalls to be aware of when creating a simulation. This paper discusses some of the key challenges in building, understanding and evaluating simulations.

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