Why Paper Trading Is Counter Productive
Why Paper Trading Is Counter ProductivePaper trading is the biggest mistake that new traders can make. This is the
most counterproductive way to learn how to trade properly. When paper
trading, every single trading decision is based on zero emotions. You are
actually training yourself how to decide entry and exit targets based on no
risk. It is a fact that the greater the risk, the greater the reward. As
paper trading has zero risk, it has no reward. It will actually increase
your risk to gain reward when you start to trade with real money because you
have been teaching yourself how to make decisions that do not apply in the
real world. When you start to make these decisions in real life, it will be
financially devastating.
In order to trade properly, traders must possess 100% technical skills, but
they only need to apply 15% of these skills when trading. The other 85% of
the equation is keeping their emotions under control. Trading profitably is
15% technical and 85% emotional. So how do you keep your emotions in check?
To do this, you must determine how much money to risk during the learning
curve that makes trading a productive and educational experience. We do not
suggest that you risk all your capital on each trade to make sure that you
are "emotionally trading the markets." As individuals, we all have a
different financial situation, and each person will have a specific zone
where a certain amount of money at risk triggers a specific amount of
emotion. Do you think a person with risk capital of over $2 million is going
to be emotional with $100 at risk? If this person buys 100 shares of a $20
stock and the stock trades down to $19, is he going to have any emotions? I
am sure that if he owned 10,000 shares in this situation, there would be a
large number of emotions involved, probably too many emotions.
No one can speak for another individual's emotional level. What each of us
must do to make trading educational is to find our "emotional risk level." I
have a friend just starting out that trades a $25,000 account. He finds that
a loss of $100 creates an emotional environment and $70 to $130 is his
emotional risk level. When this trader is risking $50, there is not enough
emotion. When he risks $500, there is too much risk and his emotions are too
powerful for him to think clearly and to make proper decisions. After this
trader had a month of experience, his emotional risk level increased so he
was comfortable, yet still emotional, when risking $400.
The secret to educational and profitable trading is to closely monitor your
emotional risk level and change your actions as necessary. This can also
mean lowering your risk capital. My friend who was comfortable with $400 had
to lower this amount to $300 after he and his wife found out they were
pregnant and decided they needed to buy a house because their rented
apartment was too small. This added more financial responsibility, and the
down payment on their home lowered his risk capital. Numerous variables can
come into play and influence a person's emotional risk level, and only you
can judge where this level should be. No one knows your situation better
than you do.
For those who are completely new to direct access trading, paper trading can
be helpful only when you are learning the software platform. It is not wise
to begin trading with real capital while trying to learn software. If you do
not know how to set up charts, watch lists, order entry, hot keys, and if
you are not familiar with the Level 2 screen, trading in demo mode is
recommended when you follow a specific set of rules. Most demo accounts
allow you to trade with a $1-million account. They also provide you with
fictitious order fills. So in order to learn properly using a demo account,
you must follow these guidelines:
1. If you will be opening a $50,000 trading account, make sure that the demo
account size is $50,000 and not the standard $1 million. Ask your broker to
change the default demo amount to your actual account size. The reason is to
make sure that you do not get used to risking more money than you have. If a
new trader is used to risking $100,000 in demo mode, he is more likely to
risk too much when he "goes live" trading real capital.
2. You should trade share sizes that meet your emotional risk level. You do
not want to get used to trading 2000 share lots when, in reality, you will
be using only 200 shares or whatever amount meets your emotional risk level.
3. Ignore unrealistic order fills that overpay for each trade. Trading
simulators will often fill your order at a price that would never happen in
the real world. If you want to buy a stock that is currently trading at $20,
place your order for $20.05 and when you want to exit, do the same. If the
stock moves up to $21, place your sell order for $20.95. This helps the
trader get used to real life order fills. You do not want to get used to the
paper profits that would never occur in real life.
4. Create real emotions while paper trading. Find a friend to compete
against in demo mode. For each point that you win, the other player must pay
you $5 and vice versa. (Make sure you place a cap of $100 during your
friendly competition.) This helps bring emotional trading decisions into the
equation.
As soon as you are comfortable with the trading platform software, stop
paper trading and start trading live, but make sure you stay within the
lower limits of your emotional risk level during your first week. You will
become a successful trader more quickly trading in live mode than if you
trade in demo mode. Continuous paper trading will decrease your odds of
successful trading because after doing something repetitive, it becomes
instinct. Trading an unrealistic account size, unrealistic share sizes,
getting unrealistic order fills, and trading unemotionally with no real risk
repeatedly will provide you with instincts that are useless and
counterproductive. When you decide to trade live after paper trading, you
will actually trade at a level below someone with no experience. Before you
can advance, you will have to shed all of your bad habits.
Author: Ryan Cooper
Website: www.stockteacher.com
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