Paper trading is a great way to get familiar with how the stock market behaves, gain some experience without risking real money, and develop an investing methodology. But at some point, if you’re interested in another type of paper—the kind with dead presidents on it—you’ll have put real money at risk.
The transition from paper trading to real trading seems like it should be a smooth one. After all, paper trading accounts like the one offered by TD Ameritrade on the thinkorswim® platform are designed to simulate the same conditions you have with a funded account. But there are other hidden dangers when real money is on the line.
Emotions in Motion
Despite the benefits of paper trading, the one thing that it can’t account for is the way emotions can influence your decision making. Even a cool and calculating paper trader can “freak out” and abandon a strategy when losing or making money.
Having real money on the line means that your buys and sells are no longer theoretical, but have an actual impact on your bottom line. All too often this reality can cause a new trader to personalize the profits and losses and abandon a well-developed paper trading strategy.
This is why it’s important to continue tracking and evaluating real money trades just as you did with your paper trades. Then, if you find that you’re not as profitable as you were before, you can compare track records to see what changed between paper trading and live trading.
Ready to Run? Try Crawling First
But perhaps the most important thing you can do to ensure a smooth transition to real trading is to go slowly. There is no rule that dictates the minimum amount of money you can trade, which is why so many traders start off with small positions. Really small positions.
If a paper trading methodology is sound, then the idea is that it should work no matter what size positions you trade. But since you won’t know how you’ll react emotionally until you put some skin in the game, consider starting with positions of smaller dollar amounts at first.
See how you react to fluctuations in price and if they cause you to abandon a strategy. If not, then slowly increase your position size up to a point you’re comfortable with and that does not exceed any position sizing rules you have in your trading plan. Many traders waste years trying to find an optimal position sizing, one that maximizes return while managing risk. Starting small and building slowly is an effective way to gradually work toward your optimal position size.
Paper trading is great for developing trading skills without having to risk a dime, but there are certain intangibles you can only learn by trading a real money account. And because of that, there will always be bumps when transitioning between the two. But by keeping an eye out for these potential pitfalls, you’ll be more likely to avoid or at least minimize them.
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