I’ve read a few option books.
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Tuesday, July 17, 2007

5 Tips For A More Effective Virtual / Paper Trading

In the earlier post, we discussed the advantages & disadvantages of virtual / paper trading. Whether paper trading will be useful for you or not depends on how you treat it: will you treat it seriously, or will you do it just for a fun game and/or self-satisfaction.

The following are 5 tips for you to have a more effective & fruitful paper trading:

1) Develop your trading system and write down the rules of the system in details.
Having detailed rules is important, because this will guide you into your decision making process, as well as to pinpoint which part of the system you need to adjust / improve during your trade reviews and to gain consistency in your trades.

2) Follow the rules of the trading system / strategy you want to test strictly.
The purpose of your paper trading is to gain trading skill and/or test the system if it works well consistently for you, not to see profits from your paper trades. We can’t deny that we feel happy, proud or satisfied if we can make profits even if it’s only virtual money. Why? Because it will boost our confidence and self-esteem. When you can’t even make money from paper trades, you’d feel demotivated and it hurts your pride as well. So, perhaps without realizing or even knowingly & purposely, we begin to be undisciplined and turn paper trading into a game to see profits because you know that there is no (financial) risk in doing so. This will defeat the purpose and make it just a waste of time. In addition, you also risk yourself into a bad habit that you may carry on in your real trades.

To have an effective & fruitful paper trading, it’s important that you paper trade exactly according to your rules of your trading system you’re testing. Set your virtual capital to what your planned capital would be. This is the time for you to learn the trading setups, entry & exit strategies, position sizing & money management, and make necessary adjustments to the system. And do not do things that you would not do in real trades, like playing a much bigger trade than what you will do in real trades later (e.g. buying call options $100,000).

3) Always keep records of every single paper trade you make (trading diary of your paper trades).
This way, you can learn from your own trades. Reviewing the trading diary of your paper trades will enable you to identify which parts of the system that needs to be adjusted / improved.
I admit that this is tough and taking time. But, this will also train your discipline. You’ll need to keep a trading diary of your real trades anyway. So, treat it as a practice of discipline and good trading habit development.

Dr. Alexander Elder in his book Come Into My Trading Room: A Complete Guide to Trading said:

There is only one good reason to paper trade – to trade your discipline….
If you have the willpower to repeat this process daily for several months,
then you will have the discipline for successful trading with real
money.

4) Start with real trades only after achieving consistency for some times.
If you cannot make money following your system in paper trading, you would not make money in real trades as well. You should start your with real trades after you can achieve consistent, profitable results for about 60% - 70% by strictly following your trading system.
When you start with real trades, it’s wise to start it with small trades. This is like a final test of your trading system while engaging your emotions into the system, as discussed in the earlier post. Through this, you’ll learn how to control your emotion in real trading.

5) Do your real trading based on the trading system you’ve learned / tried with consistent results during paper trading.
Be discipline. If you can’t find the setups you’ve been paper trading, or your rules are not met, then don’t trade. Don’t get tempted to enter a trade based on a setup you’re not familiar with. You should have a mentality that “you don’t need to trade today”. Don’t force a trade. Not trading is also a strategy.

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