The idea of paper trading can seem like a tedious time waster to those of us who are eager to get started in the World of the financial markets. By starting with real money we can immediately tap into the excitement of the markets and start earning the millions we have always dreamed of. However, jumping straight in with real money very rarely works. There are several reasons for this: we have no robust strategy, the strategy we have that we believe to be robust is in fact a loser, the signal service we use is poor at best and is incapable of producing profitable trades and the most profound reason of all: we have no idea of the emotional roller coaster trading with real money creates and how it effects our decision making skills.
Patience On Paper Pays
Each of these problems can be overcome but this article will focus on the latter. Therefore we will assume that we have a profitable, proven strategy that has shown its effectiveness in a range of market conditions and we have proven our ability to work with our strategy (yes this means paper trading!). At this point I would like to stress the importance of paper trading. If you can’t make money in a practice account then guess what, you will just be giving money away in a real account. Sure, we’ve all done it but just don’t do it again OK! There is no substitute for patients in the financial markets and if you are the sort of person who lacks this quality (the sort of person who will skim read this article) then you will need to learn.
Fear Of Loss
Paper trading teaches us how to implement a strategy. It teaches us how to follow rules and recognise patterns, it even teaches us the basic of market dynamics such as how to enter an order. What it doesn’t teach us however is how to manage our emotions. Someone who has never traded with real money will be all to unaware of the emotional and psychological side of the vocation. Sure, there is some emotional involvement in our paper trading; we all want our strategy to prove itself and our skills to be refined with experience producing a higher success rate. However this emotional involvement doesn’t even come close to what we will feel on the first day our real money is at stake.
Changing Our Plans
As emotional discomfort increases so does the likelihood that we will change the way we trade. There is a common vicious circle that first time ‘real money’ traders expose themselves to that can quickly spiral out of control. Fear of loss can lead to hesitation on entries and exits. Now losing trades become even larger and winning trades are reduced in size or missed altogether. The first seeds of doubt are sewn and a trader will begin taking riskier entries in order to recoup what he/ she has missed out on. When these riskier trades begin to lose trading accounts begin to take a real battering and self-doubt controls our thoughts. Hesitation and frustration will lead to even more losses and most traders will either give up an emotional wreck or a few thousand dollars worse off, quite often both.
David Thorpe is a senior contributor for http://www.passion-trading.munbuns.com a free educational resource centre for traders and investors. The goal of the site is to stimulate the minds of its users, enabling them to achieve a greater understanding the art of trading, thus helping them to become more profitable.