Worst Case Scenario

Calculating the “worst case scenario” answers: “What would happen if every position I currently hold goes against me and triggers an exit?”

I used to trade without knowing my WCS, but it's like walking through a messy room with the lights turned off.  

The question I came to was, “how could I run a profitable trading system without quantifying my total portfolio risk? If the shit hits the fan, where will I stand?”

The necessary prerequisite to calculating the WCS is establishing a hard exit before you enter a trade and using a trailing stop on winning positions. While I know many investors don’t have hard exits in positions, it is in my opinion that reading this article will do you little good without having that foundational knowledge.

If you do want to build the necessary knowledge on how position sizing, timeframe, initial exits, and trailing stops interact with each other, all of this info is archived here.

Trading may seem confusing and overwhelming, but good trading needs to be treated like any other business if it's going to be successful. Given enough time and effort, the murkiness becomes crystal clear.   

Essentially, the “worst case scenario” is losing all of the Total Open Risk in your account. Once Total Open Risk is calculated, you can determine how bad the worst case scenario could be.

1: Before finding Total Open Risk, you must determine Individual Position Open Risk.

2: The Excel cell formula for Individual Position Open Risk is “=(Price of Asset - Exit price) x number of shares.

3: After finding each Individual Position Open Risk, you can then find the Total Open Risk, which is just the net sum of every Individual Position Open Risk.

4: In Excel, the cell formula for Total Open Risk is “=SUM(column containing Individual Open Risks)”

*To remember: open risk is always changing because asset prices and exit prices are always changing. If you set up an Excel(or GoogleSheets) spreadsheet the right way, as you update asset prices and exit prices, the Individual Position Open Risk and the Total Open Risk will automatically adjust to the changes.

Below is a small sample of some trades I’m in. Hopefully the visual adds clarity.

As you can see, I have my assets listed in column A, current price in B, current stop price in C, # of shares in D, and Individual Position Open Risk in E.

So for ARTNA shares, I’ll go into Cell E4 and type, “=(B4-C4)*D4” and hit enter. GoogleSheets does the calculations for me. As long as I have columns B, C, and D filled out, I can just drag the bottom right corner of Cell E4 and it will do all the calculations for all of my assets.

In a separate Cell to the right, I will write the formula for Total Open Risk, which is “SUM(E4:E8)” for this sample.

Now that you can determine Total Open Risk, you can know how bad the worst can be. Right now in this account, my maximum estimated WCS downdraw is 10.5%. I’m comfortable with that number, but if it was at 60%, I may want to sell off some assets to pare back my risk.   

It took me about 8 months to get to this point in my trading system, so do not feel discouraged if it all seems like a different language.