Tuesday, 7 April 2015

3 Reasons Why You Should Not Paper Trade

Before I begin, for those of you who do not know what paper trading is, it is basically trading on a simulator.

Investopedia defines it as 
"Using simulated trading to practice buying and selling securities without actual money being involved."

Shouldn't it be a good thing to practice with virtual cash before moving on to the real thing? I beg to differ. I will share with you 3 reasons why I think paper trading is not just ineffective in teaching you how to trade, but also detrimental.

Learning To Deal With Losses

When you make a loss with virtual money, it is not even remotely similar to making a loss with your own money. The psychological stress you face when you see an unrealised loss in your account can make you do things you might not do if it were fake money.

When you make a loss on the virtual account, at the back of your mind, there is this "safety net" that is telling you that you can always restart and try again. Try telling yourself that when you have are actually at risk of losing your capital. You can easily brush aside losing virtual funds, but no one ever forgets losing real money. 

One must learn how to deal with losses properly and the only way to do that is by actually losing real money in the market. There's no substitute for that.

Risk Management

This is kind of related to the first point. Without that fear of losing money, paper traders will be more willing to take on bolder decisions, make high-risk decisions and even trade outside their trading plan. Over time, these can become bad habits when transitioning to trading with real money. If not, they will change their entire strategy to fit their risk level. Either way, what have they learnt?

Unrealistic View

For those of you who play Zynga poker, you know that it is all too easy to go all in with $10000 and earn a huge profit. But would you really go all in with $10000 in real life? It is the same with paper trading. Trading with $10000 virtual funds is not the same as trading with $10000 real cash. It simply isn't. If you paper trade for too long, I can assure you that when you transition into a real trading account, you will be making drastically different decisions and there will be a lot of conflicts with your trading strategy. 

Of course, there are benefits of paper trading, but I believe that one should only use it to get familiar with the functions of the platform and how everything works. Once you get comfortable with the platform, move on to the real account. If you are afraid, risk lesser. It is still better than paper trading for a long period of time. 

Just like life, failure is inevitable. But the point is to learn from it and avoid making the same mistake twice. Similar to trading, making mistakes and losses are all part of the process. How you deal with it and incorporate it into your trading philosophy and strategy is what makes the difference.

As always, happy trading.



Post a Comment