Scenario analysis is the practice of writing down, before the outcome is known, what you will do if several possible conditions occur, and what evidence would invalidate each idea. It is a plan of actions for possible outcomes, not a claim that any one outcome will happen.
How it works
For each scenario, write three things: the condition that would appear, the action you would take, and the evidence that would invalidate the idea.
It keeps the risk decisions in the plan, so each possible outcome is tradeable instead of a surprise.
Why it matters
Scenario analysis prepares actions while predictions claim certainty the market does not offer.
A plan that covers several outcomes and their invalidations is more robust than one that assumes a single forecast.
A simple market example
Before a data release, a trader writes: if the number beats expectations, do X with a stop here; if it misses, do Y; if it matches, do nothing. Each branch has its own invalidation, written before the release.
Common mistakes
Treating scenario analysis as a prediction of which outcome will happen.
Writing scenarios after the outcome is known, which turns them into rationalizations.
Frequently asked questions
Is scenario analysis the same as prediction?
No. A prediction claims one outcome; scenario analysis writes your actions for several, none of which is required to happen.
Does it cover everything?
No. It prepares actions for the outcomes you could name in advance, not a claim to have covered all possibilities.
How is it used in a trading plan?
It is part of the review and risk components: what you will do per scenario, with each branch's invalidation written before the outcome.
Educational content only. Definitions describe common market usage and may vary by jurisdiction, instrument, or institution.