Counterfactual
How do we reason about what a different choice would have produced, when only one outcome actually happened?
In plain words
A counterfactual is an imagined version of events in which one choice or condition is changed, so we can compare the outcome we saw with the outcome we would have seen. Only the actual outcome is observed; the alternative has to be constructed, and it is as good as the assumptions used to build it.
Why it matters
Risk reviews and trade post-mortems constantly use counterfactuals: would this position have survived if sized smaller, or closed if a stop had sat a few percent lower? The answer depends on assumptions about how the market would have responded to those orders, which is why an alternative path can never be quoted with the same confidence as the realised one.
In a real week: BTC, week of 5 August 2024
In the week of 5 August 2024, BTC opened at 58161.0 and closed at 58712.59, a 0.95% gain, after ranging from 49000.0 (Monday 06:00 UTC) to 62745.14 (Thursday 23:00 UTC), a 28.05% range. Monday was the worst day at -7.12% and Thursday the best at +11.88%. A stop placed at the Monday low would have exited before the best day; a hypothetical outcome that presumes no effect on price from the stop itself.
A common mistake
Treating the constructed alternative as an observed fact. A counterfactual assumes the rest of the week unfolds identically, ignoring that different positioning can change liquidity, timing and the path of prices.