Paper trading, demo trading – what is it?
We talk about paper trading when you are trading with virtual money. Years before simulators you simply put trades on a piece of paper. When you felt ready to trade on real account, you made a switch. In 1930’s it wasn’t that easy to open brokerage acount, besides fees for opening and closing trades were also high. Paper trades were good solution – you were able to learn how to trade without losing real money.
Paper trading in XXI century
Now when we are talking about paper trading, we mean trading on simulators. Of coure you can use pencil and paper, but trading on simulator is much better way to go. You can easily open a demo accout and get access to trading platform so you can test it. Your demo account is funded with virtual money and you can place orders.
The main advantages of paper trading
- you do not put at risk real money – your loses ang gains are virtual, so there is no risk that you will lose all you trading capital
- you can test your trading system and different trading strategies
- in Forex you can see how to use leverage
- if you are using mechanical system, you can test it in practice
The main disadvantages of paper trading
- you do not put ar risk real money – you react different when it is real money you are losing
- you make trades that you normally wouldn’t make with real money
So is paper trading a good way to learn how to trade?
It depends. If you are new in the markets or you want to test totally new strategy then yes, it is ok.
I would say that paper trading is very important when you want to start trade on Forex. As you know, on currency market we are using leverage. There are different position sizes. The basic one is 1 lot. You can open position as big as couple lots (for example 5 lots), or position smaller then 1 lot – this will be microlot or nanolot. If it sounds not familiar then you have to test it on demo accout. Thing is, with leverage it is very easy to blew whole account in matters of few minutes. It is crucial to master how to manage position size and understand well how it works. Leverage can be your best friend or the worst enemy.
When you are building mechanical trading system, then it is also great possibility to test it on demo account. So again, paper trading in that case is not that bad.
In a long term, paper trading is not the way to learn how to trade. You should switch to real account with small funds. Why? Because of…
When you paper trade and switch to real money trading, you will notice difference. Now you care. When you are losing money, you feel fear. You hesitate to close losing position “because it may turn around” (yeah, it always does 😉 ). When your trade is in profit, you are greedy. You hesitate to close position, because it may go even higher. Hell, this may be a trade of your life.
This kind of emotions occurs only when you are trading with real money. You will learn over time that most of your loses come from not following trading plan and allowing emotions to play too big role in your decision making process.
You are not able to switch off your emotions. On the other hand, you have to be aware of them and not allow to take controll. That is why you need to have your trading plan on paper.Write down as many things you can in your trading plan – that way you will minimize impact of emotions in your trading.
Ok, so let’s see where paper trading is in trader education proccess.
Paper trading in trader learning process
1. Open demo account
2. Build strategy and trading plan
3. Test different position sizing techniques – add to trading plan size of positions
4. Test your trading plan – set goal such as do not lose money in next 3 months etc.
When you are profitable…
5. Open real account
6. Fund account with money you can afford to lose
7. Set realistic goals and trade according to your trading plan
8. Trade smaller positions!
When you are profitable…
9. Increase position size
In this article I tried to show you that paper trading is not that bad, but it should be part of learning process.