A friend recently asked me if I still paper trade. My answer was, “Of course!” My friend then asked: “Haven’t you been trading for a long time? You still don’t know what you’re doing?”
I answered, “Yes,” and then, with a little irritation, “I paper trade because I do know what I’m doing. It’s my way of learning how to trade new instruments and strategies.” If you’re in a trade with real money and ask, “The trade is going against me, what do I do?” or “I have a profit, should I get out?”, it may be a good time to take a step back and consider paper trading. Let’s discuss my reasons for continuing to paper trade.
How do I Learn a New Trade?
As traders, we should always research new approaches to trading and managing money. Masters in Trading has been a great resource for expanding my trading horizons. When I first started trading, I would hear about a new approach and thought I could learn the trade with real money and small size. After a few successful small trades, I would immediately increase my size and move on to the next idea. Not surprisingly, I consistently ran into trouble.
A trade would go against me, I wouldn’t know how to manage the trade, emotions would kick in, I’d bail and take my loss (only to have the trade then move in my favor), consider the new trade idea a bust and move on to the next great sounding idea. You know what comes next – I would see someone take the trade the next time around and have a huge winner! I needed to change my approach if I was going to be a successful trader. I finally followed the advice of veteran traders and started paper trading to thoroughly understand how to manage a new trade before committing real money.
What are my Goals for Paper Trading?
When I’m learning a new trade or trading a new instrument, I want to develop full working of knowledge of the following through paper trading before committing real money:
- What are the instrument’s specifications? What is the underlying? How is value determined? What is the value of a tick? What are the margin requirements? When and how does the instrument settle? What hours does the instrument trade?
- How is the trade constructed?
- What is my time horizon?
- What tools will I use to develop an opinion or view? What factors will drive a change in my opinion and then what will I do?
- How much capital will I commit to the trade?
- How will I determine my entry points? If and when will I add in?
- How will I manage the trade if it goes against me?
- How will I manage the trade if I have a profit?
- How will I trade around a core position?
- How exactly will I enter and exit the trade on my platform?
I will commit to as many paper trades as I need to verify the consistency of the strategy, ensure the strategy fits with my approach to trading, compliments my other strategies and is within my risk parameters.
What are the Advantages of Paper Trading?
As you can already see, there are a number of advantages to paper trading:
- Learning in a stress-free environment while not risking real money
- Developing a thorough understanding of the trade
- Building your memory bank of experiences with the trade
- Developing a trade plan so you know exactly what to do at each point in the trade
- Developing the discipline to follow your trade plan
- Evaluating trade results to see if this is a trade for you
- Gaining experience on how to enter and exit trades on your platform
- And most importantly, developing the confidence that you can manage the trade within your risk parameters no matter what happens!
What are the Limitations of Paper Trading?
One of the most frequently mentioned limitations is that paper trading does not spark the emotions experienced when trading real money – fear and greed don’t kick in. That’s true, it’s much easier to “perfectly” manage a paper trade but this approach develops the three key elements that help manage your emotions when live trading: a memory bank of experiences, a detailed trade plan and confidence in the trade and your abilities. Keep in mind that many platform paper trading functions may not fully reflect commissions and slippage and may use delayed quotes.
How Long Will I Paper Trade?
I will paper trade until I’ve met the goals identified above and then, take a few more paper trades. I may also paper trade to regain my confidence if I hit a rough patch. It’s tough to fight the emotional draw of missing profitable trades and starting to trade too earlier. But remember, the markets are not going anywhere, and the trade will still be there in a month, 3 months, or 6 months! As we say in Masters in Trading Discord, “There’s always another train coming!”
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