What is Paper Trading?
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Finance > Investing
Apr 18, 2007
What is Paper Trading?
Over the years I have trained many traders and I always advise that they spend at least three months paper trading before they go live with real money. Now even though I advise this I have never had a student actually do it. They all give up on paper trading after a few weeks and go live. Why is that? They become impatient, they think they have mastered it or they think they don't need that much time. There is a good argument for not paper trading first as no matter how much paper trading you do you will never get the emotional involvement that you have when you have a real live trade on. The fact remains however that you need time to familiarize yourself with whatever system you are using. Finding out you don't know how to operate your dealing system or you don't know the correct terminology to use when speaking with your broker on the phone when trading live is a recipe for disaster. You need time to get used to how to operate your system. Whichever system you use you must know it inside and out. This is part of trading. It is one of your main tools and should be taken seriously. Paper trading is simply using imaginary money with imaginary trades. In the old days you would look at the financial newspapers and write down the imaginary trades on a piece of paper, which is where the term comes from. Virtually every broker now offers a free demo of their system and will fund your account with an imaginary amount of money e.g. $50,000. This will let you make trades just like you would if it were your own money in the account. The system will also calculate your profit and loss automatically. Take this time to experiment with the system. Make mistakes. Press the wrong button. Buy when you really meant to sell and so on; it cost nothing at this stage. One last thing on paper trading. Take it seriously. If you can't make money on paper then don't even think about using real money. I know to many traders who didn't make money on paper but for some inexplicable reason thought that if they had real money in the account they would. If you are at all serious about this game, approach it professionally. If you aren't making money on paper go back to the drawing board and rethink your plan. Charts You can use any reliable on line charting service you want. Just make sure they provide the basic analytical tools e.g. the capability to draw trend lines and can you can add moving averages. There are so many charting services out there that it would be hard to mention anyone in particular. Just type 'charts' into your favorite search engine and thousands will pop up. Many charting services specialize in only one security e.g. they only provide charts on stocks. First decide what you are going to trade then find a good charting service at a reasonable price. If you are going to trade intraday you will need real time charts with no delay. Brokers Before selecting a broker make sure they are regulated by the financial services authority in the country you are in. Nearly all countries regulate their brokers and require them to register. I would suggest you contact your country's government body that regulates brokers and ask them for a list of brokers. They will be more than happy to supply this to you and you can then choose one based on personal choice or location. Method Of Trading Now a days nearly every broker offers some kind of on line trading. You no longer need to call your broker and ask him to place the order for you. The way that it most commonly works is, your broker will ask you to download their dealing station software. Once downloaded you will be able to see all the information about your chosen security and it will normally have two small boxes, one for buy and one for sell. There will also be a place for you to enter the amount you wish to buy or sell. All you need to do is decide what you want to do and select the appropriate box. That's it, it's done. Competition is so fierce for customers these days that they may also offer you free charting software or provides charts as part of your dealing station. Leverage Stocks or other securities financed with credit, such as those purchased on a margin account are known as leveraged accounts. A margined account is a leverage able account in which securities can be purchased for a combination of cash or collateral depending what your brokers will accept. The loan in the margined account is collateralized by the security. If the value of the security drops sufficiently, the broker will ask you to either put in more cash, or sell a portion of the security. Margin rules may be regulated in some countries, but margin requirements and interest vary among broker/dealers. Up until this point you are probably wondering how a small investor can trade such large amounts of money (positions). Some market traders are permitted to trade on highly leveraged positions e.g. the forex market can have leverage of 1% with some brokerages. This means you could control $100,000 with only $1,000. The amount of leverage will depend on the brokerage, the security you are trading, and your personal financial position. Typically the broker will have a minimum account size also known as account margin or initial margin e.g. $10,000. Once you have deposited your money you will then be able to trade. The broker will also stipulate how much they require per position (lot or contract) traded. In the example above for every $5,000 you have you can take a contract of $50,000; so if you have $5,000 they may allow you to trade up to $50,00 of that security. The minimum security (margin) for each lot will very from broker to broker. Probability Before you trade it is very important that you have some working knowledge of probability in order to maximize your trading technique. Let's take a simple example. Imagine that you have in your hands a shiny new penny. The penny is brand new and has no mark's or scratches on it. A statistician would call it a "fair" coin. You decide to toss the penny into the air. It can only come down heads or tails. You know that these are the only two choices- or probabilities. Since the coin is a "fair" one, it is just as likely to fall head as tails. In statistical language, the probabilities are equal. As you continue tossing the coin you decide to keep a record of how many times heads or tails comes up. You may not be aware of it, but if you do this, you are performing one of the basic experiments in probability.
Martin Chandra is a full-time investor. He has been researching investment strategies and make his own living. For more information please go to here.
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