Paper trading

The forex market is one of the easiest to start as a beginner, and yet is also one of the hardest to make money consistently, and as we have seen, this is made all the harder by your forex broker, who not only trades against you, but also manipulates prices and spreads during volatile trading. Sadly, many new traders are so eager to enter the market and begin trading, that they start with little real knowledge of how the forex markets work, know even less about forex brokers, and in terms of a trading strategy, this could best be described as ‘make as much money as possible’. Hardly a recipe for success! Whilst there is no short cut to building up your knowledge and experience, there are various techniques you can use to help you before you start trading real money, and one of these is called paper trading.

Paper trading explained

For those of you unfamiliar with the term, at its simplest level, paper trading allows you to practice your chart reading skills, open practice trades, and practice various trading strategies using live market data, but without the risk of losing any money. Now I accept from the outset that there is no substitute for trading in a live account, where your trades are moving in and out of profit second by second. This is where the twin emotions of fear and greed take hold, as the fear of a loss, is counter balanced by the fear of losing a profit or indeed holding on for more! Paper trading can never hope to replicate the emotional turmoil you will feel once you start to trade for real, no matter whether the sums involved are small or large. When you make your first few dollars it will feel just as exciting as later in your trading career when you are making thousands. Equally, as traders we have to accept losses – it is part and parcel of making money. To become a successful trader we have to accept losses, and move on without the emotional baggage of worrying and fretting about a trade that lost money. Many people who enter the forex trading market cannot accept this fact, and following a loss will then try to exact revenge on the market immediately. This is similar in many ways to the gambler who offers a double or quits option after a losing bet. It is our attempt to get even with the market, and there will only ever be one winner when you trade on emotion in this way – the market!

Whilst many traders write off paper trading as a fruitless exercise, I do not, for two reasons. First, it forces you to begin to study candle charts on a daily basis, and to improve your chart reading skills in the process. I have been trading technically for over 15 years and whilst I am not saying it has taken me this long to learn how to analyse a chart, all markets behave differently, with differing indicators and trading signals. The forex market is unique in that there is no volume indicator on the forex chart, and therefore unlike the stock markets, we have to rely on our chart reading skills and technical indicators to highlight turning points and trading opportunities. This is where paper trading can help, as we begin to study the charts and hone our chart reading skills accordingly. Paper trading is not about making, or losing ‘paper’ money, it is about having the discipline to sit in front of a screen, watch the candle patterns, and identify the various major reversal¬† signals accordingly such as shooting stars, hammer candles, and two bar bearish and bullish engulfing candles. Combine this with some simple moving averages and a solid understanding of support and resistance, and in a matter of weeks we can begin to develop and improve our chart analysis.

The second reason I advocate paper trading is that it also forces us to develop a forex trading strategy, which we can then practice and test before putting real money on the line. Without a strategy you will fail – I can guarantee it – simply because you will then start to trade on your emotions as your positions are whipsawed by the market, and decisions will be based on raw emotion and not a predefined plan. The reason that new recruits to the army are trained so rigorously is simply that when they are under fire, they react in the same way, following a well rehearsed drill. The same is true for us as traders. When we enter the battlefield, or in our case the forex market, we need to have a well rehearsed plan, a strategy, that we follow to the letter. If it fails so be it, and if it wins, great. Any plan of course has to win more often that it loses, and part of our trading strategy will be setting our risk and money management rules accordingly, but it is the fact that we have a plan, with mechanical rules which will get us out of trouble, and stop us as traders making emotional trading decisions, which will ultimately lose.

In summary, whilst many scoff at paper trading and urge you to get started in the ‘real markets’ I do not, and believe paper trading plays a valuable role in both developing your chart reading skills as well as encouraging you to think about, develop and test your forex strategies.