Paper trading is an important step on the journey to becoming a professional trader. It is a great way to test your trading systems and strategies before you start using own hard-earned money.
For example, you might decide to take long trades in currency pairs that make 50% retracements followed by a higher swing bottom. You could set yourself a goal of taking ten or twenty or fifty or even a hundred ‘paper’ or ‘virtual’ trades, where you look for setups and follow them through as if you were actually trading them.
This could be as simple as spotting the setup (50% retracement), waiting for the higher bottom and then noting your virtual trade on paper: “Bought one Euro futures contract at 1.40, stop loss at 1.39, profit target at 1.45.”
You could follow that example trade and note whether it made a profit, a loss or broke even. After completing, say, ten trades (or however many you choose) you could look at your results and decide whether you are ready to apply your strategies to real money.
But traders quickly learn there is one major difference between paper trading and real trading – emotion. Once a new trader’s own money is on the line, they often alter their original plan.
Using the above example (buying when a market makes a 50% retracement followed by a first higher swing bottom), the trader might see a 50% retracement and immediately buy, only to see the market push through the 50% milestone without making a higher swing bottom.
Or the trader might see the correct setup but be too afraid to act on the signal, only to see it run away successfully without them. Or the trader might enter correctly but panic and exit too early. Or try to avoid a loss by holding on and letting the market go past their stop-loss. There are plenty of fraught possibilities.
Allow me to illustrate this in another way: I have recently taken up golf and have been receiving lessons from a professional. Following an early lesson, I went home to practice my swing, which I did every day. At my next lesson the pro was suitably impressed - my swing looked much better. Then he placed a golf ball in front of me and said: “Do exactly what you just did”.
Thinking I was doing exactly what I had been doing, I swung the club and shanked the ball off at an embarrassing angle!
The pro pulled out the video and we compared the two swings. When I was making a practice swing, I was calm and relaxed and the club followed the correct path. As soon as a golf ball was placed in front of me, I tensed up and my whole swing fell apart.
My instructor said: “All we need to do is sneak a golf ball in front of you without you noticing and you’ll be fine.” Golf pros are funny guys.
Of course, I was thinking and acting differently when the ball was in front of me (like real trading), as opposed to when I was just going through the motion of a practice swing (paper trading).
Whether you are playing golf or trading the markets, there is no easy solution to this problem but the first step to be aware of you are doing it.
Paper trading is a vital part of any trader’s journey but at some stage you need to step up to real trading.
When the time comes to trade for real, you will quite possibly have to confront a range of emotions, reasons or excuses that will make you want to veer away from your trading plan. Know that all traders go through this at some stage and try to execute your trading system and trading plans exactly as you did with your successful paper trading.
In many aspects of life, your emotions can be your greatest ally or your worst enemy.