A Sydney trader backtests a trend-following system. It shows 68% win rate, 2.3R average winner, drawdown capped at 12%. Looks solid. They go live with $50,000. Fourteen consecutive losses later — a sequence the backtest never showed but statistically guaranteed to occur eventually — the account is down 31%. The backtest lied. Not through error, but through sample size.

A single backtest path is one outcome from thousands of possible futures. Run that same strategy through 10,000 randomised simulations and suddenly you see the full distribution: median drawdown 14%, but the 95th percentile drawdown hits 38%. That 38% scenario isn't a black swan. It's Tuesday in a bad quarter. Most traders only ever see the median. The market doesn't care about medians.

CONCEPTMonte Carlo simulation reruns your trade sequence thousands of times with randomised order to reveal true drawdown probability ranges — not just the single historical path.
WARNINGSizing positions to survive only your backtest's worst drawdown guarantees ruin when the statistically inevitable worse sequence finally arrives.
KEY IDEARisk of ruin drops exponentially as position size decreases — cutting size from 3% to 1.5% per trade doesn't halve your returns, but it can reduce ruin probability by 80%+.

The mechanics are straightforward. Take your historical trade log — say 200 trades with documented R outcomes. Randomly resample those trades with replacement, run the equity curve, record the peak-to-trough drawdown. Repeat 10,000 times. Plot the distribution. A system that shows 15% max drawdown in sequence might show a 95th percentile drawdown of 34% across simulations. Position sizing must accommodate that 34%, not the 15%.

Monte Carlo Drawdown Distribution40%30%20%10%12%19%34%BacktestMedian95th %ileSingle PathSimulatedWorst Case

The practical output is a position sizing rule grounded in the worst credible outcome, not the best historical one. If the 95th percentile drawdown is 34% and the account ceiling for drawdown is 20%, position size must be reduced until the simulated 95th percentile fits inside that boundary. Traders typically run this analysis using tools described under Monte Carlo simulation on Investopedia, cross-referenced with foundational probability concepts covered in the Monte Carlo method on Wikipedia, and position sizing frameworks built on risk of ruin principles. The maths is not optional — it's load-bearing.

One simulation run is a curiosity. Ten thousand runs is engineering. Build your position size around the distribution's ugly tail, not its photogenic centre.

This content is for educational purposes only and does not constitute financial product advice. Past performance is not indicative of future results. Profit Logic Ltd (ACN 688 669 936) accepts no responsibility for errors or omissions in this content or anywhere on this website. Always seek advice from a licensed financial adviser before making investment decisions.