From the course: Algorithmic Trading and Stocks Essential Training
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Scenario analysis in investing
From the course: Algorithmic Trading and Stocks Essential Training
Scenario analysis in investing
- [Narrator] Practically speaking, one key tool in algorithmic trading is risk management. Risk management is crucial to making sure that your portfolio will do well under a variety of market conditions. There's two tools that you should consider for risk management purposes. One is VAR or value at risk, and the other is expected shortfall. VAR is a statistical measure that tells us the expected losses under certain ordinary market conditions. As we see in this diagram, VAR refers to the losses that we expect in the negative tail of our distribution, but excluding our worst 5% of outcomes here. So VAR tells us, in essence, 95% of the time, we will lose no more money than X. For example, a 95% VAR might say that 95% of the time, we expect to lose no more money than $1 million. If we have VAR set up properly then, it can insulate us from great risk that we're not willing to take on as a business. If our VAR limit is $2…
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