Portfolio MCS uses Monte Carlo Simulation on the daily equity curve of a basket of futures, commodities, or securities to predict probability of drawdown and equity performance and analyze risk over a specified time.
The Problem: Traditional reporting tools provide performance results from a single simulation based on historic data. For instance, results of trading the Swiss Franc, Japanese Yen and the US Bond combine into a single equity curve indicating a net profit of $250,000 and drawdown of $35,000. Assuming the markets continue to behave as they have in the past and the systems are not overly curve fitted, can we really expect to make exactly $250,000 with a $35,000 drawdown in the next 10 years? What is the probability of having a $20,000 drawdown in one year? What level of starting equity will be needed to generate a 5% or less probability of having a 10% drawdown in any given month? After realizing a drawdown of $40,000 in 60 days, should I stop trading?
The Solution: Monte Carlo Simulation can compute the probabilities of these occurrences and map the probability distribution of expected net profit and drawdown. This establishes trading guidelines for risk/return analysis based on probabilities that are derived from the behavior of the original combined equity curve. The purpose is to alert you when the system is not behaving as expected based on the original simulation. This can be caused by changes in the markets or overfitting the system to the data.

