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How Paper Trading Makes Winning Traders


For one, successful traders must control emotions. If they can do so with practice money, they may be able to do the same with real money.

Not everyone believes in paper trading. Here are the thoughts of one naysayer. The primary reason is that it's not real money, and that no emotions are involved in the decision-making process. In addition, there's a temptation to turn the paper trading into a game.

I cannot disagree more. First, the successful trader must learn to control emotions, and if you can make emotionless decisions when it's practice money, you may be on your way to doing the same with real money.

If you want to be a winning trader, you should begin by taking paper trading seriously. You must concentrate on making good decisions and it's good to experiment. In fact, that's part of the learning process. Try something, decide if that trade fits within your comfort zone, and try to learn from this new (for you) type of trade. It's an intelligent idea for trying out a new strategy.

Important: Don't decide that any new trading idea is "good" or "bad" based on one result. There's always some luck involved when investing, trading, or any other activity for which the outcome is uncertain. Consider the trade chosen and the result. Decide if the result was reasonable or an unlikely outcome. Analyze whether you were comfortable owning the position day after day. Rinse and repeat.

That's the learning process. It takes time. Please remember that there are millions of kids who want to be professional athletes. Some put in lots of practice time and are able to make their college teams. Some make it to the professional level. But very few are Michael Jordan. He didn't get there by taking shortcuts.

Practice is one key ingredient to success. Talent is another. Not everyone can be a winning trader. If you practice and learn and still cannot make money, there's no reason to believe you'll do any better when trading with real cash.

To me, the difficult part is the patience required. A day trader makes many trades over a short period of time. He or she gains experience quickly. But for option traders who hold positions such as covered calls, butterflies, or iron condors, a single trade can take a month or two. That requires enormous patience when trading with play money.

Anyone using a paper account wants to get practice and experiment with various ideas. But it does take time. You can trade real money and a practice account at the same time, but one ingredient for success is the ability to recognize when you don't know enough to make good trade decisions. It's seldom as easy as open the trade, close the trade, and deposit your winnings in the bank. Many times, questions arise and decisions must be made along the way:

Do I suddenly have too much risk? How can I fix that?

Did I earn enough profit? Should I exit now and take it?

The position isn't working. Exit or wait?

The market is suddenly more volatile. What should I do?

Am I trading proper position size? How can I find out?

The answers aren't obvious. It takes experience to get a better understanding of how decisions are made. Sure, you can trade with real money, but only if you place a very small portion of your assets at risk. If you have a $100,000 account, you can afford to trade one-lots instead of paper trading (although I recommend paper trading). But if you have $10,000, you don't want to lose $500 or $1,000 per trade just to get your feet wet. It's not worth the risk.

If you can handle multiple positions without getting confused, that's one way to learn and gain experience more quickly. For multiple positions, I suggest different expiration months or different stocks (or ETFs or indexes) to keep each position isolated from the other.

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No positions in stocks mentioned.

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