Someday every trader learns about “paper trading”. Even large trading companies offer their trainees to begin with working out a trading session in a notepad.
The question that comes to everyone is why trading in your notebook when you can use a demo account? What can one learn from “paper trading”?
Let’s look into this method of self-study to make out why it can be useful. And let’s start with guidelines so that you could evaluate the effectiveness of the recommendations straight away.
A step-by-step guide to paper trading
Step 1. Write basic parameters
First, we need to write down the basic parameters of the process, including
- the initial amount in your trading account;
- the assets selected for trading (for example, certain currency pairs or metals);
- the strategies to be applied.
This step will help you focus on a narrow list of trading instruments. Choose 3-5 assets and up to 3 trading strategies.
Step 2. Don’t forget about the limits
Specify the amount of money you are ready to lose. Remember that 100% of your deposit is not a limit, but a bankruptcy. Try to stick to 5-10% of your initial capital.
Make sure you fix your profit target. The basic rules of money management say that the profit target should be at least twice the size of the loss limit.
Step 3. Start “paper trading”
Go to the platform and study the charts of selected assets on different time frames to find the right situation. If a strategy gives you a signal, write down that you have made a trade.
Example: The RSI indicates overbought on 5 minutes time frame of the EUR/USD chart. There are no other reasons to go short. We invest $10 and set the expiration time of 20 minutes. The entry quote is 1.16120. The entry time is 10:15.
You can continue to monitor this asset. Why? The thing is that there is a psychological difference in analyzing the instrument before and after entering a trade. However, there is almost no such psychological component when you are “paper trading”. Therefore, it will be easier for you to analyze the factors that can prove or overturn your investment hypothesis.
Step 4. Summing up the results
Until your limits are met, sum up the interim results by writing them down every hour or 30 minutes.
During the break, you can calculate how much you have to earn or lose, study the efficiency of the strategies and, if necessary, change the ones that failed to meet your expectations with better options.
Step 5. Closing the session
All the trades must be analyzed again. The records you made at step 3 will prevent you from overlooking the most interesting and important moments.
You should make clear conclusions. Try to develop a new idea, which you can use in the future after each “paper trading” experience. For example, if you have been losing for several Mondays in a row while following a particular strategy, remove this system from your portfolio.
Why not a demo account?
On one hand, a demo account is the most useful training tool. Using this simulator is a must for everyone, no matter which financial instrument a trader prefers to work with.
“Paper trading” is an additional method of training. It can be useful if a trader is not satisfied with practicing on a demo account only, or wants to find other approaches to trading. Some users seem to get to the top of their preparation, but still fail to get into the green zone.
In such situations, “paper trading” can be an unorthodox method, which is definitely worth trying.
What can “paper trading” teach you?
The most useful skill you will get while “paper trading” is to think like a real trader. Read step 3 carefully.
Developing this skill will help you break through to a new level of trading. After all, the ability to explain the reasons for entering a trade, as well the readiness to admit mistakes are the defining qualities of a professional.
If you are far from this level, then it is time you tried to understand the market using a notepad and your notes.