Is paper trading useful for traders?

Paper trading does not have the same psychological feel as trading with real money. Nevertheless, it is a valuable way for a potential trader or an experienced trader who wants to experiment with a new methodology and practice their trading skills in a stress-free environment. Paper trading aims to focus on the rules of trading and not on managing stress because if you learn to focus on the rules, stress won't be a problem.

If you are a trader, it is good to remember that since trading is a zero-sum game, when you enter any financial market, you may be competing against some very specialized professionals who have more skills, more experience and larger account size. That doesn't mean you can't beat them. You can do it as long as you give yourself a chance to develop skills that professionals have. Anything less will make it impossible to succeed in trading on a consistent basis.

Practising paper trading is the most effective method to improve your trading proficiency, as it enables you to practice without the anxiety of losing actual funds. If you cannot generate profits through paper trading, it's improbable that you'll be successful in trading with genuine funds and additional stress.

Approaching paper trading with the same dedication as actual trading may result in a surprising realization: the emotional patterns experienced during paper trading can be similar to those felt during actual trading with real money.

Taking the time to delve into the psychological and emotional aspects of trading through paper trading can significantly benefit you in the long run by enhancing your trading skills. Therefore, focusing on developing your trading approach through paper trading is recommended before delving into the more complex aspects of trading psychology.

It's important not to rush the paper trading process, as the time spent on it is a valuable investment in your trading abilities that shouldn't be underestimated.

Set the rules in the form of a checklist

To begin paper trading, you should

• First, create a plan that includes establishing Trading Rules.

• Second, develop Money Management Rules.

Once you have identified these rules, you should document them as a checklist on paper.

Check if your rules require improvement to fit your needs

Once you've set your rules, start paper-trading in the same way you would trade in reality. This includes selecting the same time frame, market, and financial products and assuming that you have the same account size you plan to or currently have when trading with real money.

It is recommended that you allocate time to trade frequently, particularly in your preferred market. For instance, day trading can expedite your learning curve as it enables you to trade more often and gain more experience within a shorter period. By practising in a secure paper trading environment, you can determine whether you need to modify your rules to align them with your preferred trading style.

Keep records on the performance of paper trading

Record the outcomes of your paper trading and treat them as though you were dealing with actual funds. Employ a tracking system to monitor the performance of your trades across time.

Estimate your trades

Group your trades on paper where each group represents specific trading rules. Then in each of these groups, calculate:

• The profit/loss.

• The average win/loss.

• The maximum win/loss.

• The number of winning trades.

• The number of losing trades.

• The number of consecutive winning and losing trades.

Continuously modify

Continuously modify your trading approach by analyzing your results until you achieve profitability and a sense of confidence in your trading.

Ensure that you have profitable trading strategies

Ensure that you have three profitable trading strategies in paper trading before engaging in real-money trades. For day traders, it's crucial to spread out your trades over several days, weeks, or months to include uptrends, downtrends, and sideways trading.

Assess trading strategies in actual trading as you did in paper

Once you begin using your own funds, assign a similar worth to each trading method as you did in paper trading, and analyze the outcomes.

Consider reassessing your method

If the strategies you developed in paper trading are no longer profitable in actual money trading, stop trading and go back to paper trading.

If you are making profitable trades upon your return to paper trading, then, most likely, the problem is your psychology. And you may need additional help from a trading coach to uncover the issues that led to your psychological pressure.

If you are not profitable in paper trading upon return, you may have been lucky the first time and need to adjust your trading approach so, to adapt to different market cycles.

It's essential to find the right paper trading approach that suits your needs before determining whether the issue lies with your trading approach or psychology.

Adapt quickly and efficiently

In the event that you encounter over five consecutive trades resulting in a loss and/or experience a drawdown exceeding 15%, it is probable that the market cycle or market volatility, as well as the trading time frame, have undergone a change. In such circumstances, it is imperative that you swiftly and effectively adjust your trading plan to these modifications.

In case substantial losses emerge

In the event of significant losses during real money trading, cease such trading and revert to paper trading while maintaining the same market and time frame. Wait until you have developed three successful trading strategies before resuming actual money trading.

Revise your rules to evaluate whether this rectifies the excessive losses experienced previously. If successful, return to paper trading to validate the adjustments made. Experiment with different time frames until the most effective one is identified.

Treat trading with respect like doctors treat medicine

Trading the markets is a life-and-death situation, especially in futures and CFDs, as it is a zero-sum battlefield since one trader's profit represents another trader's loss. Treat trading with the respect it deserves, and start every trading strategy on paper first until you know what you're doing.

If it makes sense to practice a trading strategy with real money before evaluating it on paper, then it makes sense in medical school for surgeons to operate on live patients before they know what they're doing. But just as doctors learn to operate on cadavers before moving on to live patients, traders should also practice on paper before venturing into the live trading arena.

There's no reason to hesitate

Although paper trading is considerably simpler than trading with actual funds, if you've formulated highly lucrative trading tactics and assessed them based on the criteria stated earlier, there's no reason to hesitate when putting these strategies into action with real money.

If you've established that you can generate paper profits, there's no problem. Then, if it turns out that you can't be profitable with actual funds, you better fix the problem.

Paper trading is backtesting

Paper trading is essentially a method to conduct backtesting. Today many software tools of backtesting offer extensive capabilities to evaluate not only the rules of your system but also your emotions and capacity to adhere to those rules.

Is paper trading worthless?

Some readers may argue that paper trading involves too much effort and may not be worth the time. While it is true that developing three profitable trading strategies requires dedication and work, it is also true that anything worthwhile typically requires some effort. If you are under the misconception that trading profits are effortless and fast, you are probably on a path to unpleasant surprises.

Believe me, the benefits of paper trading are tangible.

After all, if you genuinely enjoy trading, practising on paper will not feel laborious since every advancement will bring immense gratification.

Overall tip

For new traders, always remember before investing your money in trading, it is recommended first to test your rules and evaluate their performance in market conditions by applying a plan on paper. For experienced traders who already have a successful trading system, it is important to keep an open mind with paper trading. Additionally, when testing a new trading approach or ideas, test them first through paper trading to see if this approach can serve as a catalyst for a new perspective on trading.