Stress Testing

Stress testing examines how an account or strategy would behave under extreme but plausible conditions, rather than under average ones. A trader might re-price open positions against a sudden central bank surprise, a spread widening several times over, a weekend gap, or a broken currency peg, and check whether the resulting equity still supports the required margin. Unlike backtesting, which replays history as it happened, stress testing deliberately imagines scenarios the sample may never have contained. It complements statistical measures such as value at risk, which describe normal conditions well but say little about the tails. The practical output is usually a limit: smaller size, fewer correlated positions, or reduced exposure over illiquid periods.