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Pros and Cons of Paper Trading


My first recommendation to all new SteadyOptions members is to start with paper trading, then start small and increase your allocation as you gain more experience and confidence. Over the years, we had a lot of discussions related to the benefits of paper trading, and this article will discuss some of the pros and cons.

Investopedia defines paper trading as "a simulated trade that allows an investor to practice buying and selling without risking real money. While learning, a paper trader records all trades by hand to keep track of hypothetical trading positions, portfolios, and profits or losses. Today, most practice trading involves the use of an electronic stock market simulator, which looks and feels like an actual trading platform. Most brokers allow to open a paper (simulated) account where all trades can be simulated. It also can be done using an options trading software such as ONE, or simply by writing down all trades by hand.

Here is the summary of the pros and the cons of paper from few different sources.
 

The Pros

  • No Risk: It costs nothing, and you can't lose money with bad decisions or poor timing. 
     
  • No Stress, no emotions of greed and fear. The trader can focus fully on the process, not the emotions.
     
  • Practice: The trader gains experience in every element of the trading process, from pre-market preparation to final profit or loss taking. 
     
  • Confidence: Making a series of complex decisions that gets rewarded with hypothetical profits goes a long way in building the novice's confidence so that they can do the same thing when real money is at stake.
     
  • Statistics: Paper trading for several weeks up to a month builds useful statistics about the new strategy and market approach. 
     

The Cons

  • Slippage and Commissions: Real money traders deal with all sorts of hidden costs from slippage and commissions. Usually it's not realistic to get filled at the mid, so the results of paper trading might be skewed.
     
  • Emotional Reality: Paper trading doesn't address or evoke real-world emotions produced by actual profits or losses. Controlling emotions in the market is hard. If you only focus on the money, you have the wrong mindset.” The game only becomes real when you have "skin in the game"
     
  • Formfitting: Paper traders pick out ideal entries and exits, missing the minefield of obstacles generated by the modern computer-driven environment. 
     

What Our Members Say

Here are some selected comments from our members, taken directly from the forum:

  • I have found real trading sharpens the mind; the learning happens a lot faster with real money. Also, with trading real money, you get a much better appreciation with how fills work.  Paper trading fills are nothing like they are in real life.
     
  • Paper trading is really good to get to know and more deeply understand the strategy but it doesn't fully simulate all (especially psychological) aspects of live trading, net net I see a valuable place for both.
     
  • A key element is effective learning/maximizing the pace of learning. In the context of maximizing learning paper trading has a clear place in developing the 'muscle memory' of the trade execution. In a paper context you can focus on entering, monitoring and exiting in a safe space (without the psychological highs and lows).
     
  • Many books and people I've read suggest paper trading for at least 6 months before putting real money on this business also, read as much as you can because knowledge is your main advantage in this game.
     
  • I am not interested in devoting the time to paper trade and can't sustain ongoing losses plus fees.
     
  • The point with paper trading is to understand the strategies, see how a trade evolves day by day, see how the adjustments impact the trades etc... IMO, focusing on paper trade fills vs live fills is missing the point of it.

My Take

The goal of paper trading is not to see if the trade is profitable or not. It's mostly to "feel" the strategy and follow the dynamics. When trading a new strategy, most traders will make mistakes, no matter how experienced they are. Those mistakes might include things like forgetting closing the trade before earnings, missing the adjustment or the closing notification etc. When you jump with real money right away, those mistakes might become very expensive.

I can definitely see and understand both sides of the argument, but just to clarify: my recommendation applies to ALL members, novices and experienced. The reason is simple: for most traders those strategies will be fairly new, even if they have years of trading experience. It's like changing specialty in medicine - even if you are a very experienced doctor, a new specialty always presents new challenges.


Here is an example from just few weeks ago. We had a new member who claimed to have 10+ years of experience. He jumped into one of the straddles on his second day. He did not read the strategy overview and relied on the trade notification to close it. He did not read the discussion topic, and not surprisingly (since he also didn't read his welcome email), he also didn't know that he needed to follow the trade topic to get the closing notification. Well, you probably guessed where does it end - he held the trade through earnings, the stock didn't move and the straddle lost around 60%.

There are many moving parts in those strategies, and even experienced traders need some time to learn them. Paper trading simply prevents you to lose money if you make a mistake (and most traders will).

 

Summary

This is taken from  one of the options trading mentoring programs website:

Plan on at least six to twelve months of paper trading and live trading to get to break even. Once you are not losing money, you can slowly start scaling your trading size up. Your doctor, attorney or pilot all started by hitting the books and then getting instruction from a current and qualified professional to teach them their trade. It is no different with option trading. It's a complicated skill set that needs a good amount of understanding before you start trading live.

I guess I'm not the only one advocating this approach.


The bottom line is: while paper trading has its limitations, both trading and emotional, I still recommend doing it, and many traders come to realize its benefits.

 

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