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Paper Trading Stocks

After you have completed the previous five steps, you are ready to start paper trading.

Paper trading (a.k.a. “demo trading”) is trading without putting any money at risk; in other words, on “paper.” When paper trading stocks or any other investment, you should try to simulate real life trading as much as possible.

This will be one of the factors that determine if you will prepared to trade with real money or not. For this reason, you do not want to take any unnecessary risk in practice mode that you would not take in real life. Unfortunately, this is where many people fail. They become cocky and overconfident while they paper trade stocks and become overly speculative rather than careful and disciplined. As a result, if they were lucky and did really well while demo trading without following the principles that they learned earlier, when they start the actual trading, they run the risk of destroying their capital due to not following the proper rules.

There are many websites out there that allow you to follow a mock (make-believe) portfolio of stocks. Doing this is dangerous and is not the way true paper trading should be done. True demo trading should be carried out using the same system or methodology you plan on using when you start trading for real.

Since those portfolio-tracking websites don’t allow you to see everything that is going on in the market when you buy and sell your stocks, you become shielded from reality and, if you are lucky, start believing that trading is very easy to do.

What you don’t really see is that you are taking more risk than you really should because the stocks might be fluctuating more than you know. Thus, you might be holding on to your stocks longer than you should and letting your losses accumulate beyond what you would allow in real life; in other words, you are not simulating reality. For that reason, you should only paper trade with the plan of attack that you will employ in the real world. (you can click here to paper trade on a demo account with real market prices)

Top of the line direct access trading systems like RealTick allow you to work with live market data while paper trading. Thus, when you place an order you know almost exactly what price you would have obtained in reality, and in the meantime, you are not losing sight of anything that is going on in the market.

Paper trading is made possible because the broker will set up your RealTick account in simulator or “demo” mode. This will allow you to start trading with a make believe amount of money and simulate actual trading results. (If you paper trade stocks with a RealTick system, the only disadvantage is that the direct access broker will only allow you to practice for a few days for free. If you want to practice for longer than that, you will usually have to pay $300 a month or more for the RealTick platform. On the other hand, if you want to paper trade currencies, you can use many live simulation systems for free. This gives you plenty of time to practice. To get free access for 30 days to the simulator I like, click here.)

The length of time that you demo trade depends on how long it will take you to get comfortable with the simulator, and with the implementation of your strategy.

This can vary from 1 week to a few months. I recommend that most people paper trade for at least a month before they trade with real money. During this time, the investor should not care so much about how much he is making or losing. His greatest concern should be answering “Yes” to questions like, “Am I learning how to work with the direct-access platform?” and “Am I buying and selling when I know I should based on the rules I have learned so far?” If the trader can honestly answer “yes” to these questions over and over again, then he might ready to trade in the real world. This means that he has created enough discipline to start slow, one step at a time.

This trader should approach trading as a business and without any emotion. He should not be ecstatic when he is making a lot of money nor sad when he is not making or losing. All of this is part of the business of trading and he should learn to welcome it as such. At no point in time should he feel invincible or useless, and, never, ever, ever, should he look back and wonder what could have been; in other words, never look back and say to himself, “If I would have kept the stock longer I would have made $5,000 more” or “I should have bought that stock” or “I am so dumb, why did I do that.” This should not be going on in a day trader’s head. His head should be like an empty rice bowl, receptive and ready to act (not full of noise). No regrets.

One last word of advice to the trader who is paper trading stocks on a simulator is to learn how to “sell short.” Selling short is one of the only ways to make money when the stock market is going down. When a trader sells short, he is borrowing the stock (a certain number of shares) from his broker, selling them right away (the money from the sale going into his account), and buying them back later (hopefully at a lower price) and returning them to his broker.

All of these things happen instantly with the press of a button to sell short. I think that learning to sell short is so important, that I recommend that traders always come up with a stock (or stocks) that they want to buy and a stock (or stocks) that they want to sell short, regardless of whether the stock market is going up or down; in other words, on his list of ideas, the trader should have a stock that he thinks is going to go up (to buy) at a certain point and one that he thinks is going to go down (to sell short).

Most traders have a strong bias towards buying a stock rather than towards selling it short. They want to buy a stock low and sell it high, even when the market is screaming to be sold short. If from the start of the paper trading stage, a trader always forces himself to find stocks that are good candidates to sell short, he might lose the emotional preference to buy stocks and might realize that he can make money whether the stock market is going up or down; besides, haven’t you noticed that stocks go down faster than they go up? Selling short in real trading and demo trading is a must. (Selling currencies short is a bit different than shorting stocks. In every currency transaction, the trader buys one currency and sells another. It is almost as if he is selling short every time he trades. This is discussed in more detailed in the currencies section.)

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