OPTIONS

Wednesday, July 11, 2007

Should You Do Virtual / Paper Trading?

For beginners, before starting real trading, it is recommended that you should prepare yourself first by spending some time to do virtual / paper trading. For those who may be unfamiliar with the term, paper / virtual trading is a trading simulation, where you can “buy” or “sell” a security with real price, but not using real money. You will be given a certain amount of “virtual money” as your “capital”, and you can place a trade through your online broker as if you were really trading.

Perhaps you have read many trading books, attended trading courses, and learnt various trading strategies. Through paper trading, you can implement what you have learnt, practice how to make a trade, and/or trading strategies, without putting your hard earned money at risk.

I know quite a number of articles have discussed the advantages & disadvantages of paper trading. The most well-known advantages of paper trading are: (1) it serves as a great learning tool to give you hands-on training; and (2) no financial risk is involved in paper trading, which means you can’t lose money.
However, many people also suggest that the 2nd advantage can actually be a disadvantage too. Why? Because humans learn from mistakes. We particularly learn more from mistakes that hurt either physically, mentally, or emotionally. When the mistakes don't hurt, it doesn't have the same effect.

Paper trading does not involve emotions, which is in fact one of crucial aspects in trading success. One can be very profitable in paper trading, but may lose money in real trading. Dr. Alexander Elder in his book Come Into My Trading Room: A Complete Guide to Trading said that one reason why this happens is that “good decision is easier to make when your money is not on the line”.
Another possible reason is that ones can do things in paper trading that they would not do with real money. For example, never use stop loss and always wait for the stock price to make a comeback into profitable state.
Why can you do that in paper trading?
Because you don’t need to deal with your emotions, fear and greed, when you are in the process of decision making. In real trades, without a stop lost, how long can you afford to see your trades keep moving against you and accumulating the losses? Depends how strong your stomach is.

Therefore, Dr. Alexander Elder suggested the following:


Still, there is no substitute for trading with real money, because it engages emotions more than any paper trade. It is better to learn by putting on very small real trades than paper trades.

I agree with Dr. Alexander Elder on this. However, I do think that paper trade is also still important, particularly for beginners. Recently, Dr. Brett Steenbarger wrote a post on how one should go about learning to trade. One of the ways to start the trading learning process is through paper trading:


3) Start With Simulation - Yes, yes, I'm very aware that simulated trading (paper trading) is not the same as the real thing. But there's a reason basketball and football players engage in scrimmage games, and there's a reason chess champions practice their game outside of tournaments. Simulation enables you to make your mistakes and learn from them *before* you risk losing in the real performance. It's also helpful to first practice skills without the pressure of making money. If you can't make money in simulated trading, you certainly are not going to succeed going live. Simulation is the bridge between learning and doing; it's an important skills-builder.

So, should you paper trade or not?
In my opinion, paper trading is not only useful, but also necessary, particularly for beginners.

When I first started learning to trade or when I’d like to try new trading system / strategies, I always begin with paper trading. After gaining consistency for quite some times in paper trades, I then try it with small real trades to involve emotions into the system testing.
By doing this, I will not waste my capital to test whether a new system / strategy can work for me. But I do agree that what works in paper trading may not perform well once the emotions are engaged in real trades. So, it’s also important to test it with small, real money as the final step of the testing.

Related Posts:
* Options Trading Basic – Part 2
* Option Greeks
* List of Some Online Stock Option Brokers
* My Online Stock Option Brokers - Sharing My Experience
* 5 Tips For A More Effective Virtual / Paper Trading

8 comments:

Anonymous said...

i agree with you that virtual trading is important. after you can make money in virtual trading, then you can do real trading.

OPTIONS TRADING BEGINNER said...

Yes, you're right. If doing paper trading which doesn't engage emotions, we still cannot make money, it's even more unlikely we can make money in real trading.

Thanks for your comment.

Anonymous said...

Started with Tradestation last year. Spent about 2 months learning the platform and reading the documentation. Afterwards spend several months studying various indexes and products to trade. Then started to write some EasyyLanguage code for Tradestation. Evaluated the rules and refinded them for several months while at the same time studying the indexes and other trading products. After all that I tested trading styles with small shares using different products. It is now a year later and I am now ramping up the positions and frequency. Doing so full time has tested my nerves and stamina. In short, steady and slow has been effective for me. Hopefully, as my position size increases I will be better prepared.

OPTIONS TRADING BEGINNER said...

Hi,
Thanks for sharing your experiences here. :)

Yes, I agree with you. It's better to start slow but steady. Many new traders are too eager to make money as soon as possible, and this may lead them to be indisciplined in their position sizing/money management & risk management.
I think, when learning trading, we should have a purpose of learning to trade first, not to focus on making money. When we know how to trade well, money will follow.

Good Trading,
OTB

Tony Chai said...

Hi OTB :

OptionxXpress provides a very good platform for practising virtual trading on stock options. I've been using it for years.

I use the analysis option at the end of every month to check how I've performed month after month.

When I realized certain month(s) with negative returns I would analyzed further to see which were the trades I've done wrong and I would learn from the mistakes.

Yours Truly,

Tony Chai

Anonymous said...

hi,
do you know some virtual trading programs?
thx, and very interesting article

OPTIONS TRADING BEGINNER said...

Hi Anon,

I use virtual trading platform from OptionsXpress.
If you want, you also can open an account with them. They allow you to do virtual trading even before you fund the account.
So, all you need to do to use their virtual trading facility is open an account with them.

For further info about OptionsXpress, you can refer to my previous post as follow:
My Online Stock Option Brokers (Part 1)

Regards,
Options Trading Beginner

franzca said...

Hi,
I'm also beginner in option and already started trading with virtual account. But it's a very big different when you doing it in the real one, especially when you trying not to be feared when it's going wrong and than doing something stupid. All we learn on the virtual one suddenly disappear..... :)
Good point bro !!
Happy Trading & wish You Luck !!
XKong-Bursa