Paper Trading: Waste of Time or Valid Learning Method?
One more purpose of this stage is to get comfortable with your tools. Configure everything as you need it for live trading. Move windows around your screens to have them placed as conveniently as possible. Start with your charting software. Play with the fonts to have all the information that you need on the screen while text is still easy to read. Play with the colors so that different windows are easy to distinguish. Learn to quickly manipulate your charting software. Change symbols, link windows, change time frames – do everything that you will need to do in the course of trading. Draw necessary lines on the charts, add and delete studies and indicators that you are going to use. Do it long enough to make the process automatic.
Learn your order routing software. Manipulate the controls, changing quantity of shares, price of your order, type of order and route. Switch from limit order to market order and back, practice changing the price quickly. Play with controls long enough to make the process automatic. See how to set advanced orders. If necessary, print out excerpts from order routing instructions and place it within easy reach.
Finally, start routing orders in a way that keeps your money safe. Do it in the following way.
Set small amount of shares – from ten to fifty. Set the price far enough from the market price to not get filled. If a stock is trading at $20, prepare your buy order at $10 and short order at $30. Send the order. Observe how a confirmation appears. Now cancel the order and observe the confirmation. Make sure that all the messages you receive become familiar so you do not spend much time reading them later. Make sure that confirmation pop-ups do not get in the way of observing the action. Observe the reliability of your quote feed, especially in the most active periods – market opening produces fast conditions when the quotes are most likely to lag. Make sure that you have trading desk phone number on a speed dial to be able to reach help as fast as possible if something happens to your internet connection or quote feed – no technology is perfect.
It’s often asked how long this stage should be. There is no fit-for-all answer. There are traders that breathe through it in a week, and I know a trader that paper traded for a full year. It doesn’t mean he was a slow learner. He just was perfecting his trading system until he was totally satisfied with it. Although a year is probably a bit on an extreme side, a week or two is not really what suits most people. This is usually not a matter of exact time that would be the same for everyone. Paper trading serves certain purposes, and you should move ahead when those purposes are achieved. Keeping all the rules of paper trading, do you show consistent profit? Have you observed how your setups work and gotten comfortable with them? Have you made sure that you know the drawdown your system can produce and that you can sustain it? Have you become comfortable with your charting and order entering software? If you can answer Yes to all these questions, then paper trade just for a couple weeks more. If not for any other reason, do it to practice one of crucial elements of your psychological makeover – patience. The skill to sit on a sideline will serve you well. It will also allow you to get into your first trading day with more feeling of self-control.
We mentioned two more cases when paper trading is appropriate.
Testing a new system or to tweak an existing one is obviously calling for going back to paper. You are changing something – why risk real money before you make sure it works well? Usually when a trader is doing that he already has enough experience under his belt to know how to paper trade effectively. Just make sure that you give it enough time so your results are statistically significant. I know a trader who does this kind of new tweak testing not even stopping his live entries and exits. While making real trades he simultaneously writes down optimized ones, comparing the results and making conclusions about the quality of optimization.
Going through a losing streak, a trader wants to find out the cause of under-performance. Is it market conditions that change in a way that ruins his system? Is it a trader himself acting in an undisciplined manner? If it’s the market, does something get changed fundamentally or is it a short-lived fluke? Does a major trend change? Is it just a temporary range contraction with no volume? What is likely to come next? These kind of questions are not easy to answer in the heat of the battle. Thus stepping aside to re-evaluate things, to regroup and to regain your confidence or to re-tune your approach is a good decision.
For whatever reason you go to paper trading, your major step to assure the success of it, is to define the purpose and to work out the steps to achieve it.