Intermediate3 min readTrading and Investing Strategies · 9/10
Scenario Analysis: Several Possibilities Instead of One Forecast
Someone who says "the stock is heading to 20" has one forecast, and if it does not happen they will not know what to do. Scenario analysis asks a different question: what could happen, and what will I do in each case?
What you will learn
Write three scenarios for a stock with clear levels.
Give each scenario a trigger that tells you it has started, and a plan.
Nobody knows where the price will go. A single forecast makes you cling to your view, and when the market goes against it you hesitate and decide late. Writing down the different cases in advance lets you decide calmly before the move happens, and then simply carry it out.
How to write them
The base scenarioWhat you see as most likely if nothing new happens: often the price stays in a certain range.
A better and a worse scenarioWhat could happen if conditions improve or worsen, such as results stronger or weaker than expected.
Trigger and planFor each scenario, a price level or event that tells you it has started, plus exactly what you will do.
Invented stock at 15
Better
TriggerA close above 16.5
PlanReview the plan and raise the exit
Base
TriggerPrice between 14 and 16.5
PlanNo change; follow the results
Worse
TriggerA close below 13.8
PlanCarry out the planned exit
Three scenarios for an invented stock at 15, each with a trigger and a plan.
A worked example
An invented stockAlexandria Detergents (an invented company) trades at EGP 15, with results due in two weeks. Base scenario: the price stays between 14 and 16.5. Better: results are stronger and the price closes above 16.5, so you review the plan and raise the exit to 15.5. Worse: the price closes below 13.8, so you exit. Holding 1,000 shares, the planned loss in the worse case is about EGP 1,200 if you manage to exit at 13.8, and it can be larger if the price gaps past that level. You knew that figure before anything happened.
Notice that the example contains no "the stock will reach X." It has cases, triggers and figures known in advance. You do not need to give each scenario an exact probability; a figure like 60% with no basis gives a false sense of precision.
Watch outScenarios are useless if you change them mid-move. If the price closes below the worse-case level and you say "I will wait another day," you are back to a single forecast. And after sudden events the price can open far from your chosen level.
Try it on a stock
Open any stock page, look at its high and low over the recent period, and try writing three scenarios, each with a trigger and a plan.