On occasion, new and veteran traders alike come to me to ask about the importance of paper trading. A little bit of probing often tells me that they have never actually paper traded before. I normally encourage them to go for it, but they nearly always refuse – in their minds, the Ultimate Goal of Trading in the equity or Commodities markets is to Earn And Keep a Lot of Money, and trading a live account is the Sure-Fire Way to do this over “pointless” paper trading.
You might do a spit-take after You have read this, but it is possible to earn more cash by beginning with just paper trading. In this article, You will read just How Important Paper Trading actually is, and how it can help Earn You a lot of Sweet, Sweet green in the future.
Please take note that in modern terminology, “paper trading” is used to broadly label any type of a system’s test run. These types of system test can include demo trading, back testing, forward testing, and etcetera.
Mind Over Matter?
As You enter the trading game for the first time, and when You are still learning the ropes, ask Yourself this – what is more Important: the technical knowledge/aspect (technical analysis and fundamental analysis) or the trading psychology/aspect?
Most people would say that both the technical analysis and the fundamental analysis are Important. Conversely, a few people believe the opposite – that learning the psychological aspect is essential.
Each group is right – both of them are vital, because a trader cannot operate without understanding them both.
Despite this though, many traders still struggle in becoming Successful – it may be because many do not know how to strike a balance between the two.
If You wish to know how to walk the fine line, read onwards.
The Technical Aspect
Unfortunately, as mentioned above, most traders do not bother with paper trading, as they want to dive straight into live trading. These types of people often have a “learn by practice” approach, which is very risky because of the amount of money involved in live trading.
While practicing the technical aspect is essential, You do not have to live trade in order learn – paper trading allows You to practice with Minimal Risk. If You make a mistake, the consequences would be far less severe than that of a live trade gone wrong.
If You do not Agree with this perspective, You are most probably thinking that the traders who do not trade live money do not understand or grow to understand the emotions and psychology involved with trading – the aptly named psychological aspect.
Newcomers, the Best Way to learn and understand the technical aspect is to Stop Worrying about how You will feel during and after the trade. Keep Your focus narrowed on learning the technical aspect of Software , until You’ve become proficient at it – push Your feelings and emotions to the side. My advice is to use Minimum 15 Days For Paper Trading. – it is the Best Way for Winning Trades.
There is a potentially costly trap that many New traders often fall into – they hypocritically say that learning the technical aspect is vital, yet at the same time use live trading to try and understand the psychology aspect/their own emotions.
It is risky –very risky and most ill-advised– but possible to do this. Unfortunately, time has shown that many an over confident trader have failed to learn both simultaneously – emotions conflict and interfere with rational choices. When this occurs, the new trader is confused and unable to understand why the trade failed – was it because of the psychology aspect interfering, or was it because their system was flawed and problematic?
In addition, they can also end up breaking their own trading rules, because of the influence of unchecked emotions impacting their decision-making. By doing this, the trader will not be able to tell if their system is functional and Profitable, through lack of sample-trade examples.
The end result is not only they have compromised their system beliefs, but also their self-confidence and any positive feelings they had.
And so, like a dog chasing its own tail, they end up going around and around and around….
The Psychological Aspect
The psychological aspect is very Important, too – though to be perfectly frank, whilst learning and understanding trading psychology is more Important than learning and understanding the technical aspect, it is very hard to become proficient in it if You do not have a firm grasp on the technical side of things.
A few of You might be imitating chimps right now, scratching Your scalps in confusion. I firmly believe that the psychological aspect is one of the key elements, in Your trading career. Most people, sadly enough, cannot understand and appreciate trading psychology, unless they’re a current or a former-trader.
It’s all like a particularly daunting amusement park ride – when You get on, You feel and embrace the thrill, the rush, the feelings of rising and falling…
But underneath that Fun lies all the mechanical work: the system itself. Before Your ride (Your trading analogue being the live trading account) could have even be built, a sound engineering plan had to have been designed beforehand (trading analogue: Your trading plan), with Safety Features (trading analogue: risk management)
Unfortunately for them, many traders want to build their ride without having a solid, hardy design, which then proceeds to blow up in their faces.
It’s quite the problem, no?
Paper Trading – a Safer Answer
Now You Can Understand why paper trading is both Safer and Very Important. Your goal should be to separate the technical aspect from the psychological aspect; to control and understand them both without either influencing the other.
There is also the fact that trading for real money is quite the emotional ride – it’s a resource that can either make Your career or ruin it. Think of it all in another way: if You knew nothing about handling explosives, would You jump straight into being a demolition expert? If You (sanely!) agree that You would not, then why would You do the same thing with real money?
When I try to explain all of this to my fellow traders, they typically ignore my advice because of their pride and ego, and they often try to rationalise their course of action – even when something at the back of their mind is screaming at them that paper trading is the right way to go.
I’ve been there myself, trust me – even I struggled to return to paper trading, after thinking it all through!
Below are some helpful suggestions:
- Test Systems First by using Paper Trading
When You want to test out a New Trading System or when You Wish to add one into Your portfolio, always paper trade test them First – keep tweaking and altering it until its desired results are consistent.
A fraction of people will find this difficult, because they don’t really pay any attention to trades that don’t risk any real money. This is only true, however, if they do not set a viable target or goal (such as a Dozen Winning Trades or a certain percentage gain) before they’re slid over to a live trading account. This will all also Act As Encouragement and Positive Reinforcement for the trader in question.
- Create a Second, Smaller Account
A good alternative to reducing Your trading account is to transfer a small amount of money to a newer, smaller account – good brokers can usually and easily handle their clients having two or more active trading accounts.
Once the secondary or sub-account has been established, use it as a test-bed for trade systems that are either new or just barely profitable. You can then experiment to make them more effective, as well as allowing You to trade with a greatly reduced risk factor (compared to the risk factor You would have had, if You had used Your main account, instead).
Remember, do not implement any new systems to Your main account until they are Consistently Profitable!
Now You can understand why it’s so Easy for New Traders to become confused in regards to handling their trading systems (the technical) and their feelings (the psychological). This is one of the greatest obstacles that a trader, of any experience, must Claim Victory over.
These two aspects must be separated and managed independently of the other, lest conflict and consequences occur. By paper/demo trading, this can be accomplished, allowing those traders who practiced it in the past to Become More Successful than those who just “dived right on in”.