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How can you use stress testing and scenario analysis to evaluate your commodity trading strategies using TA?

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Commodity trading is a challenging and rewarding activity that requires a solid understanding of market dynamics, supply and demand factors, and technical analysis (TA). TA is the use of historical price patterns, indicators, and trends to forecast future movements and identify trading opportunities. However, TA is not a foolproof method and can be affected by various sources of uncertainty and risk. Therefore, it is important to evaluate your commodity trading strategies using TA with stress testing and scenario analysis. These are methods that simulate different outcomes and conditions to measure the impact on your performance, risk exposure, and profitability. In this article, you will learn how to use stress testing and scenario analysis to evaluate your commodity trading strategies using TA and improve your decision making.

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Ajibola A.

LinkedIn Top Voice??//Data Analyst// Educator//Business Analyst//Financial Market Analyst

1 What is stress testing?

Stress testing is a method that applies extreme or adverse scenarios to your commodity trading strategies using TA and assesses how they would perform under those conditions. For example, you can stress test your strategies by changing the price volatility, the market direction, the liquidity, the leverage, or the correlation of different commodities. The purpose of stress testing is to identify the potential losses, risks, and weaknesses of your strategies and to adjust them accordingly. Stress testing can also help you to set realistic expectations, plan for contingencies, and manage your emotions.

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Ajibola A.

LinkedIn Top Voice??//Data Analyst// Educator//Business Analyst//Financial Market Analyst
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Once you've identified stressful scenarios, apply them to your TA-based strategy through simulation tools or backtesting. Analyze the resulting performance metrics like potential losses, drawdown (peak-to-trough decline), and risk-adjusted returns

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Jorge Eduardo Dyszel

Passionate Educator, Risk Management Consultant, Base Metals & Financial Guru & Coach
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Most of the ideas are clearly explained by my colleagues except one. I am convinced that, after the pandemic, the nature of the economic being has changed. Its character has been completely altered. The behavior of market variables is something else entirely, completely different. What does this mean? That if you are going to use models from the past, you can clearly use them, but with extreme conditions. All classical theories must be questioned. How to deal with all of this in concrete terms? Well, all the scenarios you imagine should be exaggerated at the extremes and in the middle. All the hypotheses of risk consequences should be expanded. You must be very creative in outlining adversity. You should not work alone.

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Nathan Anneh

Futures Trader ($NQ) at Topstep | CEO, ANNEH CAPITAL LLC | Chess Enthusiast
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Stress testing involves subjecting commodity trading strategies using technical analysis (TA) to extreme or adverse scenarios to evaluate their performance. This method assesses how strategies would fare under conditions such as heightened price volatility, market direction shifts, liquidity changes, leverage adjustments, or altered commodity correlations. The aim is to uncover potential losses, risks, and weaknesses in strategies, enabling necessary adjustments. Stress testing aids in setting realistic expectations, contingency planning, and emotional management within trading practices.

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2 What is scenario analysis?

Scenario analysis is a method that creates plausible or alternative scenarios to your commodity trading strategies using TA and evaluates how they would perform under those situations. For example, you can create scenarios based on different economic, geopolitical, or environmental factors that could affect the commodity markets, such as inflation, trade wars, supply shocks, or climate change. The purpose of scenario analysis is to explore the possible outcomes, opportunities, and threats of your strategies and to diversify them accordingly. Scenario analysis can also help you to anticipate market changes, adapt to new trends, and exploit market inefficiencies.

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3 How to conduct stress testing?

Conducting stress testing for your commodity trading strategies using TA requires defining your objectives and parameters, selecting relevant and extreme stress scenarios, applying those scenarios to your strategies, analyzing the results, and adjusting your strategies accordingly. For instance, you can decide to measure the maximum drawdown, risk-reward ratio, or Sharpe ratio of your strategies and change the price volatility, market direction, or leverage of your trades. Additionally, you can apply backtesting, forward testing, or live testing tools to simulate your strategies under the stress scenarios and measure their performance. Following this process can help you visualize your results in charts, tables, or reports and identify strengths, weaknesses, and areas of improvement of your strategies. Finally, you can modify entry/exit/stop-loss rules, position size, or risk management techniques to improve your strategies and reduce losses.

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4 How to conduct scenario analysis?

In order to conduct scenario analysis for your commodity trading strategies using TA, you must first define your objectives and parameters. You should then select scenarios that are relevant, plausible, and alternative for your strategies. Afterwards, apply the scenarios to your strategies and calculate the results. Subsequently, analyze the results and compare them with your objectives and parameters. Lastly, diversify your strategies based on the results and feedback. For each step, you can utilize tools such as backtesting, forward testing, or live testing to simulate your strategies and measure their performance. Visualizing the results with charts, tables, or reports can help identify opportunities, threats, and areas of improvement of your strategies.

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5 Benefits of stress testing and scenario analysis

Stress testing and scenario analysis are useful methods to evaluate your commodity trading strategies using TA and improve your decision making. By employing these methods, you can test the validity, reliability, and effectiveness of your TA methods and assumptions, measure and manage your risk exposure, volatility, and drawdowns, optimize and fine-tune your trading rules, parameters, and techniques, plan for different market conditions, events, and situations, diversify and balance your portfolio and strategies, as well as enhance your confidence, discipline, and consistency.

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Jorge Eduardo Dyszel

Passionate Educator, Risk Management Consultant, Base Metals & Financial Guru & Coach
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The ability to create stress scenarios is not only useful for working on risk but also for working on original and constructive solutions.

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6 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?

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How can you use stress testing and scenario analysis to evaluate your commodity trading strategies using TA?

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1 What is stress testing?

2 What is scenario analysis?

3 How to conduct stress testing?

4 How to conduct scenario analysis?

5 Benefits of stress testing and scenario analysis

6 Here’s what else to consider

Technical Analysis

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How can you use stress testing and scenario analysis to evaluate your commodity trading strategies using TA?

1

2

3

4

5

6

1 What is stress testing?

2 What is scenario analysis?

3 How to conduct stress testing?

4 How to conduct scenario analysis?

5 Benefits of stress testing and scenario analysis

6 Here’s what else to consider

Technical Analysis

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