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Start Trading Real Money Early

Wed, Jun 14 2006, 09:04 GMT
by John Forman

Anduril, Inc.

Take a look at Figure 1 and Figure2. Can you tell the difference?

Figure 1:


Figure 2:


They look identical, don’t they? They should. It’s the same instrument. It’s the same data. It’s the same trading platform. Even still, though, if you have a position on in this market, the two charts could look quite different, depending on whether you are trading a demo account or with your own real money, especially if you are new to trading.

Actually, if you’ve just switched from demo to live trading, you’re probably looking at Figure 3, which is the 5 minute version of the other, hourly, charts.

Figure 3:


Why is this? Because things change when you actually have money at risk. For a lot of new traders, the transition from paper trading to real trading is a traumatic one. The relaxed, confident individual is replaced by someone who is suddenly compelled to watch the market tick-by-tick, someone who hesitates to pull the trigger on trades, someone who second-guesses her/himself, and/or someone who finds her/himself less willing to take on risk.

The limits of demo trading

Let’s face it. Trading on a demo platform is essentially a game. There is no real risk involved. As such it does not replicate real trading, at least from an emotional perspective. Yes, a good demo platform provides the trader with a look at how prices move, how transactions are handled, how profits and losses are derived, and all that important stuff. As such, it is an invaluable resource to someone new to trading as they learn the steps. A demo platform is also a great tool for the design and testing of new strategies.

Paper trading, though, cannot suitably create the same kind of mental scenarios one faces when actual money is on the line, though. This is a hugely important part of trading.

The markets will strip you down. Of that you can absolutely be sure. If you have some flaw in your work ethic, discipline, motivation, or anything else, trading will expose it. Some things may come to light through demo trading, but more than likely they will be overlooked because that kind of trading “doesn’t really matter” so one has no real motivation to address anything of that sort. It is when real money is on the line that the cracks in one’s make-up really show. The earlier a trader can figure out what her/his personal weaknesses are, the quicker they can be addressed.

Successful traders are the ones that understand their personal flaws. They either find ways to exploit their strengths while keeping their weaknesses out of play, or make personal adjustments to get rid of those habits which cause them trouble.

Pitfalls of going live

In this modern day, demo trading and real-life trading is mostly very close. In some cases, brokers have identical platforms for both. Other do not, though. That means trade executions could be significantly different, especially during high volatility periods such as when major economic releases are reported. This sort of thing can make a very meaningful difference between how one’s trading goes when demo trading and when it gets shifted to real-world.

From the mental side of things, traders seem to go one of two ways when they first trade with real money. They are fearful, afraid of losing money, or supremely confident, sure that they will succeed. Those with trepidation generally suffer from second-guessing, failure to pull the trigger, and general uncertainty. The confident traders often fly by the seat of their pants, put on trades too big for them, and generally fail to follow their plan.

Interestingly, both types of traders can find themselves following a similar path as they first put their own money at stake. The tendency is to spend too much time in front of the screen – regardless of the actual trading timeframe in question. This is represented by our discussion of Figure 3 earlier. New traders often have their market focus zoomed in to an extreme – living and dying with every change in price. And depending on whether their first trade is a winner or loser, they can flip personality types, with the fearful one becoming confident and the confident one becoming fearful.

This whole period of getting overly focused on short-term price action (relatively speaking) doesn’t just stop at producing manic emotions. It can actually lead to a destructive pattern of over-analysis. One side of that is the hesitant behavior mentioned earlier in regards to fearful traders second-guessing and/or failing to pull the trigger. Call that over-thinking.

The other side of over-analysis is actually that one literally generates new analysis much too frequently. This is a major trap for professional analysts who are expected to always have something new to say. They essentially reanalyze the market with each new price bar. The result is that their analysis never has an opportunity to mature one way or the other. Because of how focused new traders often are on every price move, significant or otherwise, they also struggle with over-analysis in much the same way. It leads to things like flip-flopping positions, not out of fear, but because of a new outlook on the market.

Further, over-analysis has a very dangerous cousin in the form of over-trading. If one is constantly reanalyzing the market, then it is likely that he/she is trading more frequently than perhaps is best. This is a different kind of over-trading from taking on positions which are too large relative to one’s capitalization (a money management discussion for another day), but can be equally as destructive – more so in some ways.

Learning from the jump

So what can a novice trader do to learn the most when making the move to live trading while keeping the “tuition” as low as possible? First and foremost, trading small is imperative. Trade the least amount permissible in terms of size. This will allow for the making of all kinds of mistakes without doing too much harm to one’s financial standing. Education costs money one way or another, but there’s nothing which says one has to pay more than is necessary. In modern trading there are so many options for trading small positions that there is no excuse for the new trader to take oversized losses.

If one starts off trading small, miniscule even, then the focus can really be on what is important – learning about the practical aspects of trading. That includes both the price and execution side of things where it relates to variances between demo and live trading platforms. Even more importantly, it also means learning what kind of psychological impact trading is going to have.

A major learning element of moving to live trading is in the area of risk tolerance. The reality of facing losses in actual money terms forces a great many traders in to reevaluating their personal risk profile. Considering how important this is to one’s trading plan, it is something very significant in the education of a new market participant.

The other big element one must evaluate when shifting from demo to live trading is discipline. This is something which is spoken about over and over and over again as being perhaps the single biggest deciding factor in a trader’s success. It is the ability to stick to one’s plan. Moving in to real money trading tests the novice trader’s discipline in so many ways. Those that go on to have success have good discipline, either in terms of finding a trading style which matches their personality (making discipline easy) or developing a basic grit-your-teeth kind of focus on executing.

If one gets nothing more than a better understanding of her/his personal risk tolerance and the importance of maintaining good discipline, then making the jump to live trading early is more than worth the cost of whatever losses might have be incurred. Anything else is a welcome bonus.

Conclusion

Learning to trade is all about getting to the point of being successful with real money in real market situations. Demo trading definitely has its place, but the introduction of live trading early in one’s development can accelerate the overall rate of learning by showing one exactly what must be addressed for success, mechanically and mentally.

It is hard to ensure a level of success in the process, as one might do in other learning environments. After all, the market doesn’t care whether you have two minutes trading experience or two decades. It will treat you the same. At least, however, one can minimize the potential damage by taking baby steps and trading very small when the initial plunge is made.

What’s more, there is nothing to say that once one jumps in to real money trading that he/she cannot move back over to demo trading. In fact, that can be a great way to develop solid trading methods, ones which can be researched with no monetary risk, but with a clear understanding of how implementation will take place in a live situation. All the more reason to get exposed to live trading as early as possible.

Published on  Wed, Jun 14 2006, 11:31 GMT