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You probably have heard of paper trading, but do you know that most people are doing it wrongly and it ends up being a waste of time?

As a new trader, does it make sense to start off with paper trading and what is the correct way to do it?

In this blog post, I’m going to talk about paper trading, the correct way to do it, and discuss whether it is worth your time doing it.

If you would like to learn all the essential elements to kickstart your trading journey, also check out: The Beginner’s Guide to Trading & Technical Analysis

 

 

What is Paper Trading?

Firstly, what is paper trading?

Paper trading or demo trading or virtual trading, is the idea of trading with fake money, thus simulating the experience of trading yet avoiding the risk of losing any money.

Basically what this means is that you use a virtual account or a demo account and this simulates trading but you are not actually using any real money to trade.

So, in this sense, you do not actually lose any money.

When you are starting out, it makes sense to start with less capital or fake money, and focus first on honing your trading skills.

You can then always scale up or use real money as your skill gradually improves.

This makes sense because for new traders, most of the mistakes are made when you are starting out and so the idea is for you to minimize the cost of those initial mistakes by using fake money.

This can be a good idea for the first 10 to 20 trades where you just want to get an idea of how to execute the trades and the process of managing those trades, however the main problem with paper trading is that you cannot learn any real trading psychology if you just do paper trading.

Because if you recall, the mindset or trading psychology is a major factor in trading success.

Imagine playing poker with fake money. Is it still the same experience? Definitely not.

Because trading similar to poker in many ways, test your ability to make good sound decisions under the stress of having money at stake.

Without any skin in the game or any real money at stake, the experience is just not the same.

 

Ways to Paper Trade

What are some of the ways that you can paper trade?

The easiest way is to simply use pen and paper or a spreadsheet to record your trades.

For example, if you’re browsing the charts and you spot a good opportunity, and you decide “I’m going to buy x number of lots at this price” and you record down the trade, then as the price progresses you can record down “I’m going to exit at this price”, and whether you made a winning trade, how much you made, etc.

This is a more manual way of recording your trades.

But now with a lot of software available in the market, such as Tradingview or if you are using any brokerage platforms, they usually provide you with a demo trading account, so this allows you to trade on the products that are available on the platform where you can buy and sell the products using a demo account and all the transactions will be recorded.

It’s easy for you to refer back to all the transactions and trades that you have made.

These are the 2 easiest ways of paper trading.

 

How to Paper Trade Correctly?

Next, how do you paper trade correctly?

Earlier on, I mentioned that many people are doing it wrongly and hence it ends up being a waste of time.

If you want to get the most out of your paper trading, there are 3 important things that you need to take note of.

The first is you need a trading plan, like I mentioned in my previous videos.

Check out: How to Craft a Winning Trading Plan (The 7 Key Ingredients)

Before you place any trades, whether it’s on a real account or demo account, you need to plan out the trade fully.

You need to know what strategy, what time frame, what product, where you’re going to enter and exit your trade.

You need to have everything planned out before you even take the trade, because if you’re going into paper trading and you’re just randomly buying and selling, then there is no learning
or experience at all because you don’t even know what you are doing, so whether you win or you lose, at the end of the day, you have no idea whether what you did was right or wrong.

The second thing that you need to have is the trading journal.

Check out: How to Create a Trading Journal (And Discover Your Edge in the Markets)

Basically, you want to record down the whole process of your decision making, your buying and selling, what emotions are involved, the decisions that you made, why you made all these
decisions, because all these data from your trading plan and your trading journal will help you formulate and improve your strategies such as when you go to real trading.

The last thing which is the most important, is to treat your paper trading account or your demo account as if it is a real trading account.

This is the closest thing you can get to simulating the trading psychology, because if you treat your fake money as real money, then at least when you make the decisions, you will apply your proper money management and risk management rules.

 

Pros & Cons of Paper Trading

What are the pros of paper trading?

Firstly, there is no risk involved because you are using fake money on a demo account so even if you make a lot of beginner mistakes, for example you you accidentally key in the wrong orders,
or you press the wrong buttons, it doesn’t matter because you can then reset your account and do it properly the next time.

In a way, it’s a cost-free way of learning and making mistakes.

The next thing is to gain confidence because as you familiarize with the platform and the ways of executing the trade, you also gain confidence in your strategies and at the same time, you are also testing out whether the strategies work.

This works best if the demo platform you are trading on is the same as the actual platform you will be trading on once you move into live trading.

After paper trading for a period of time, if you are actually making good profits, it means that your trading strategy probably should work in the real market as well.

The third point is that in a way, it is also forward testing your trading strategy because after deciding what the strategy is in your trading plan, you are now testing it forward as opposed to back-testing.

What are the cons of paper trading?

The most obvious one like I mentioned before is that there’s no skin in the game, so it is hard to learn trading psychology when real money is not involved.

The next risk is overconfidence because you might think that you know you are doing very well on paper trading, only to realise it is not the same when it comes to real money.

This phenomenon is something I frequently noticed when I was trading professionally at hedge funds.

A lot of people do well on the demo account or the paper trading phase, but when it comes to real money, they somehow lose that confidence or they become too overconfident and thus, they
tend to blow their accounts.

The next point is slippage and commissions.

When you are trading with paper trading or demo accounts, it may not necessarily accurately reflect any slippage or commissions, which are the transaction costs that are involved in real trading, so you might want to take note of that, especially if your trading strategy involves a lot of transactions, then this could become significant.

The last disadvantage for paper trading is if you are just looking for a way to see if your strategy works, then back-testing does a much better job that paper trading.

You can test easily 10 to 20 strategies, by computerizing it so that you can test multiple strategies at one time before you even start trading.

Hence, back-testing is way more efficient if you are looking for a way to see if your strategy works.

 

Summary of Paper Trading

In conclusion, my advice to new traders is to start off with paper trading for about 10 to 20 trades, then move on to trading a small account with real money.

You can get used to being able to execute trades when you are doing the paper trading phase, but eventually when you move on to the real account, then you can see how their trading psychology is like when there’s real money at stake, so it doesn’t matter how small you start with as long as it’s real money, then you can slowly scale up and gain confidence trading real money.

To sum up, what I would recommend is to:

  • Use back-testing to test your strategies and once you have a good strategy, then you
  • Use paper trading to familiarize with the process and after that once you are familiar with the process, then you
  • Move on to real trading to train your trading psychology.

That is the whole flow and the process of progression in trading.

So now that I’ve shared the correct way to do paper trading, do you still think paper trading is useful and have you tried it out for yourself?

Let me know in the comments below!

Have you ever wondered why you keep making the same trading mistakes over and over again?

As you start your trading journey, one very important habit to cultivate is to have a good trading journal, which is why in this blog post, I’m going to share with you how you can start a trading journal and use it to effectively improve your trading results.

If you would like to learn all the essential elements to kickstart your trading journey, also check out: The Beginner’s Guide to Trading & Technical Analysis

 

 

Trading Journal #1 Plan New Trade

The first thing to record is the planning of your new trade.

You should already have a trading plan before you even start trading, but before you actually execute the trade, it is good to record down the trade in your trading journal.

  • Why are you taking this trade?
  • Why is this a good trade?
  • What is the strategy behind it?
  • What is the reason or the rationale for you wanting to take this trade?
  • What are the pro factors? The negative factors?

Everything should be recorded down, basically your whole thought process of your decision-making of how you come about to decide whether you want to take this trade or you want to pass on this trade.

So all that should be recorded down in your trading journal for future reference.

 

Trading Journal #2 Execute Your Trade

Next is the execution of the trade.

  • What was the reason and analysis of each decision point during the trade?
  • For example, when you’re making the entry, why are you entering at this price?
  • Why not wait a little bit later?
  • Why not enter at a better price or when you are going to exit the trade,
  • Why do you want to take profits?
  • Why not let the trade run further?

All these things should be recorded down in your trading journal.

Basically, why you make every decision along the way.

 

Trading Journal #3 Record Your Trade

Next, you’re going to record the trade itself in your journal, meaning all the trade parameters.

You’re going to record:

  • What type of trading style was it?
    Was it a long-term trade? A medium-term trade, a short-term trade?
    So that will correspond to whether it’s position trading, swing, trading, or day trading.
  • And what was the product that you traded?
    Was it forex, a stock, an option or a derivative?
  • Next, what was the timeframe?
    Was it on a 5-minute chart, a 1-hour chart, a daily chart, a monthly chart?

These are all the standard perimeters that should be recorded down in your trading journal.

Next up, you should also record down your entry price, stoploss price, and target price. These are the bare minimum parameters that you need to have for each trade.

  • The entry price (EP) is the price that you entered the trade.
  • The stoploss price (SL) is the price that you get stopped out.
    So if it’s a losing trade, and you got stopped out, then you record the price which you got out or if you didn’t get stopped out, you also record down the stoploss price, because that is the price that intended for it to be the stoploss.
  • And lastly, the target price (TP) will be the price that you choose to take profit at.
    If you actually stagger your trade, for example, you take half profits at certain price or decide to trail, and shift your stoploss or different variations of position management.

All this is useful information to see whether the position management strategy that you’re using is actually effective, or maybe it might be too complicated and decreasing the optimal returns that you should be getting.

Next, you should also attach a chart of your entry and exit in your trading journal.

Ideally the chart should be labeled with as many things as possible. Other than your entry and exit, you can label where you shift your stoploss or scale in or out of positions.

You can also choose to label your thought process directly on your chart.

So for example, if you choose to make your journal soft chart-based, then you could also record down most of the information directly on your chart, and then you’ll save a screenshot of it.

It might be easier for you to reference. All you have to do is just look through all the different charts, compilations. All the information is already on the chart.

However, it will not allow you to effectively analyze the data.

If you record it on a spreadsheet instead, then it’s easier if you want to do analytics to review the numbers and your profits.

This is a trade-off. Or you can do both if you have the time.

But the bare minimum you should have is to at least have an attached chart so that when you look at the chart, you can remember what this trade was about.

 

Trading Journal #4 Record Your Emotions

Lastly, the most important thing is to record down in your trading journal is your emotions throughout the trade.

Many traders tend to neglect this aspect because they think that they just want to record the hard data, so they don’t really record down how they were feeling or why they made this decision.

But trading is an emotional activity.

It’s largely psychological, but your emotions still do play a big role.

A large part of trading is how well you can effectively manage this emotion.

So the first step to understanding or managing the emotions, is to be able to record it down.

For example, when you were taking this trade,

  • Were you feeling fear?
  • Were you afraid that you might miss out the trade or feeling greedy?
  • Or were you feeling hopeful or hesitant because maybe you were previously been burned in your last trade?

All these emotions are very important because subconsciously, they may affect your decision-making.

 

Trading Journal #5 Review Your Trades

The next segment is how to use these data that you have collected from your trading journal to improve your trading results.

The frequency at which you do your review will depend on your trading style.

If you are doing swing trading, then maybe you can do a review at the end of every week; if you are day trading, then you could do it at the end of every day.

The main point of this review is to look for areas of improvement.

What are some of the things that you should be looking out for?

  • Did you follow your trading plan?
    You should have a trading plan before you even start trading, so you can compare the before and after, (your trading plan versus your trading journal), how closely do they match up?
  • If you deviated from your trading plan, why did it happen?
    Was it because of certain emotions or was it some impulse?
  • So with that, then you need to decide whether it is the plan needs to be improved or whether it is you who needs to improve so that you can be more disciplined to follow the trading plan.

The next level is to go down to each individual trade, for example, for every trade:

  • Why was it a winning trade?
  • Why was it a losing trade?

Just because a trade is a winning trade doesn’t necessarily mean that it was a perfect trade or you did everything correctly because there’s an element of chance.

Even if you broke all your trading rules and you traded horribly, there’s still a chance that you might end up with a winning trade, but that doesn’t necessarily reflect your ability to trade.

And it definitely doesn’t mean that you should replicate this behavior in the future.

It’s important to not just see the trade as winning trade equals good trade and losing trade equals bad trade, but to understand the underlying reasons for why it was a winning trade and why it was a losing trade.

For losing trades, was it due to poor execution or was it due to market conditions?

So similar to the idea put forth earlier, just because a trade was a losing trade doesn’t necessarily mean that it was a bad trade because you can do everything perfectly and executed everything according to plan and it could still turn out to be a losing trade simply because no trading strategy is 100%.

Even if your trading strategy is 70%, there is still a 30% chance that the trade will be a losing trade, even if you did everything correctly.

The key thing is to see how closely you follow your plan, whether you execute everything according to your plan.

As I said earlier, it’s a matter of reviewing everything and seeing whether the plan needs to be improved and changed, or whether it is you who needs to improve your discipline, such that you can be less emotional and be able to execute the plan which you have come up with.

And that is the key to being a good trader.

 

Summary of Trading Journal

So to sum up, I’ve shared with you 2 main segments of the trading journal.

The first was all the things that you need to record in your trading journal. (Parts 1 to 4).

That’s how you can create a good trading journal.

The second part is how you actually use this information to improve your trading results. (Part 5).

So remember that all successful traders, even professionals, they keep a trading journal.

And in fact, this is quite a standard practice for many of the funds and financial institutions, especially for some that I used to work at.

It was common practice that they want all the traders to have a trading journal so that when you are reviewing it with your manager or your bosses, there’s a record and it actually helps them understand your trading style and your trading decisions on a day-to-day basis.

Even if you are trading on your own, it’s actually very important to have this trading journal because you will be able to better understand yourself as well.

Only you will be able to figure out your strengths and your weaknesses.

So having this trading journal gives you a window into your own trading psyche and allow you to fine tune your trading strategies and thus, improve your trading results.

For all new traders out there, do you currently have a trading journal and for seasoned traders, how useful is a trading journal when you were starting your trading journey?

Let me know in the comments below!

You’ve probably heard that you need a trading plan before you start trading, but how exactly do you go about crafting one?

Now, if you’ve ever tried to start a business, you will know that you need a business plan, which tells you the A to Z of everything you need to do for your business, the step-by-step process you’re going to execute your plan, your strategy, and all that.

So the same thing applies to trading.

You need a trading plan before you start trading.

And today I’m going to share with you the 7 key ingredients that you need to craft a winning trading plan.

 

 

Trading Plan Ingredient #1 Trading Style

The first thing you need to do is to determine what is your preferred trading style.

Now, there are three main types of trading styles: day trading, swing trading, and position trading.

The main determining factor would probably be the amount of time that you can afford to spend on trading.

So if you are doing it as a full-time job, or if you have a lot of time to spend, then you can probably consider trying day trading.

And if you like the fast-paced environment and making quick decisions, then that may be something for you.

On the other hand, if you’re just doing it as a part-time endeavor where you have maybe an hour or 2 a day to spend on trading, then you might consider swing trading instead where you take longer-term positions, more in the medium to long-term position instead of going in and out of the market, such as like in day trading.

Lastly, if you do not have much time at all to spend, then probably the most effective thing for you to do is position trading that you take long-term positions that could last weeks or months.

So this does not require you to spend a lot of time analyzing the charts on a day-to-day basis.

 

Trading Plan Ingredient #2 Trading Timeframe

Now, the second factor to consider is the timeframe.

Now this corresponds closely to the trading style that you choose.

For example, if you are day trading, most likely you’ll be using an intraday timeframe such as the 5-minute chart or the 15-minute chart, or even the 1-hour chart.

On the other hand, if you are swing trading, most likely you’ll be using a timeframe such as the hourly chart, the 4-hour chart or the daily chart.

And lastly, if you are doing position trading, which is a long-term endeavor, you’ll probably be using the daily chart or the weekly chart, or even the monthly chart.

 

Trading Plan Ingredient #3 Product Selection

The third major ingredient is the product.

Now, this is the trading product that you are choosing to specialize in.

For example, it could be things like forex, stocks, bonds, commodities, derivatives, cryptocurrencies, options, etc.

There are actually many different products, so you need to find a product that suits your trading style, suits your personality, something that you are going to be familiar with.

 

Trading Plan Ingredient #4 Risk Management

Now, this is the part that determines how you allocate your resources.

So for example, one thing to note is your starting capital, which is the amount of capital that you are going to start with, because this will determine your trading size and the risk that you’re going to take for each trade.

So for example, a common calculation is to risk 1 to 2% of your capital per trade, depending on how much risk you want to take.

If you are starting with $10,000, then you will probably be risking 2% of $10,000 per trade, which is about $200 a trade.

And the other thing you need to take note off, is the open risk on all your trades.

If you are risking, say 1 or 2% on each trade, you need to ask yourself, what is the maximum risk or maximum drawdown that can happen if all the positions that you have open at one time, all get stopped out simultaneously.

So when that happens, what is the total amount of risk?

And that is known as the open risk.

If you’re risking 1% a trade and you have 5 trades that all go sour at the same time, you lose 5%. So 5% is your open risk.

You want to limit your open risk to less than 5% because you don’t want to lose a large chunk of your capital at the same time.

It’s ideal that you have a limit to the monthly drawdown that you incur, because you don’t want to have a scenario where you lose a large chunk of your capital in one time period, because if you will lose too much capital in one month, then in the next month, you have no more capital to trade.

If you are not doing well this month, it will be ideal to perhaps take a break from trading and you can come back to fight the next month.

 

Trading Plan Ingredient #5 Type of Analysis

The next major category to look at is the type of analysis that you are going to be using.

Now, there are three main types of analysis: price action, classical charting, and technical indicators.

Now, each of these is a complex topic that I have created other tutorials on.

So the main thing for you is really to decide which one you are going to specialize in.

But most of the time as a trader, it’s important to actually learn and master all the three different techniques because you are going to use them in combination in certain ways.

And that actually leads you to formulate your trading strategies, which is number 6, the type of strategy that you are going to be using.

 

Trading Plan Ingredient #6 Type of Strategy

Now, personally, I feel that most trading strategies will fall under 4 main categories: breakouts, trend-following, counter-trend and market reversals.

So if you look at your strategy, you want to be able to see which category it falls under so that you can better understand, what are the strengths and weakness of each strategy.

To help you out, I have other tutorials that cover each strategy in greater detail.

So, what are the different strategies that I use?

Breakouts are when price breaks to new highs or new lows.

Trend-following is more like finding an opportunity to ride on a strong trending market.

So usually you look to enter on pullbacks.

Counter-trends are usually opportunities where the market has gone to certain extremes, like too overbought or too oversold. Knowing how to pinpoint and target those counter-trends, is the essence of counter-trend trading.

Lastly, market reversals are like the big kind of reversals or turns in the market.

They do not happen that frequently, but when it does happen, you want to be aware because it leads to a change in the major trend.

 

Trading Plan Ingredient #7 Trade Execution

The final 7th ingredient is the trade execution.

Now there are three key parameters that you need to determine before you decide to enter a trade.

And that is the trade entry, the stop loss and the target price.

The trade entry is the price at which you are going to enter the trade and that is determined by the strategy and the setup that you are using.

The stop loss is the price that you are going to get out of the trade.

So, a stop loss is there to protect and limit the amount of loss that you are going to incur on the trade.

There are certain types of stop loss, such as the fixed stop loss, the trailing stop loss and all these should be part of your trading plan.

And finally, the last thing is the target price, which is where you are going to take profit on a trade if it does go in your favor.

So you need to have certain preset rules, for example, how are you going to project a target price?

Or how are you going to determine where’s the optimal point to scale down your positions or to get out of the position totally?

 

Trading Plan Bonus Ingredients

Now that I’ve covered the seven key ingredients to a winning trading plan, there are some other things that you might want to include as well.

For example, evaluation metrics.

How do you going to measure and improve the performance of your trades, as well as trading psychology rules that you can implement to prevent you from making cognitive biases or mistakes in your trading.

So remember that the key purpose of having a solid trading plan is to separate the execution phase from the planning phase.

Ideally, the moment the market opens, you are focused on executing your trading plan and you no longer have to strategize because if you are trying to do both at the same time, it is going to be really difficult to concentrate.

Therefore, that is the idea of a trading plan.

Now that I have shared the key ingredients in my planning plan,

What are some of the things that are missing from your trading plan or things that you think can be improved on?

Do let me know in the comments below.