Monte Carlo simulation in gold trading

Monte Carlo simulation takes a strategy’s list of trade results and generates thousands of alternative sequences, by shuffling the order or drawing trades at random. Each sequence produces its own equity curve, maximum drawdown and longest losing streak, giving a distribution of outcomes instead of one history.

How it applies to gold trading

A backtest shows only the order in which trades happened to occur. If a strategy’s worst losses were spread out in history, the backtest drawdown looks mild; the same trades bunched together would produce a much deeper one. Monte Carlo reveals that risk. Traders typically look at the 95th percentile drawdown, the level only 5% of simulations exceed, and size positions so they could survive it.

The method assumes trades are independent and that future trades resemble past ones. Gold’s regime changes can break that assumption, so treat the output as a stress test, not a forecast.

Worked example

Example (hypothetical numbers): 300 gold trades with a backtest maximum drawdown of 9% at 1% risk. Across 5,000 reshuffles the median maximum drawdown is 11%, the 95th percentile is 18% and the longest losing streak at the 95th percentile is 12 trades. A trader with a 10% drawdown limit would cut risk per trade to about 0.5%.

A common mistake

Treating the original backtest drawdown as the worst case. It is one sample from a wider range.

See also: Drawdown, Losing streak, Risk of ruin, Walk-forward analysis.

Frequently asked questions