I wanted to give an alternative viewpoint on paper trading that’s in contrast to what was stated in Seminar Two at Investors Underground (the new paid chatroom).

I’m coming to find out this is a two-sided disagreement that has gone on for a long time between the pro and con sides of paper trading. But for any new traders with less experience than me (which would be 90 days or less), I want to offer a counter take on the subject. A lot of people find my blog by googling “paper trading”, so hopefully they will find this post.

I personally think it is retarded to use real money in a complex and complicated activity such as day trading before you have at least a basic to intermediate command of the skills and knowledge necessary. Even if you are an accomplished trader, if you are testing out a new strategy, there’s no shame in testing it out live on paper in addition to backtesting it.

Pilots use many hours of flight simulation in their training. With today’s technology, there are ways to make this experience more realistic than in the past. In trading, these are some ideas on how you can make the practice more real:

1) Account Size: Paper trade the amount of money you have in real life. If you have only $5K, there’s no sense in sim trading with $100K (because that’s fantasy!)

2) Realtime Platform: I think this is very key; if you read my posts from November, I first started using the Virtual Stock Market, but it was delayed 20 minutes, both quotes and execution. For practice day trading, you must utilize a platform that gives real time quotes and transactions. Brokers like Think or Swim (what I use) and Interactive Brokers give their clients this capability if you deposit the minimum they require into your brokerage account.

3) 100% Self Honesty: If you lie to yourself about entries and exits, then you are wasting your time. But if you are using a sim trading software program, there’s no way to fib on that as your transaction history tells the story. But I know paper traders that just literally use old fashioned paper notes to record their trades.

4) Better to Trades Stocks with Volume and Tight Spreads: Getting order fills on illiquid stocks in real life can very difficult. In paper trading, TOS takes the average between the bid and ask to calculate the price a stock for transactions. In paper trading, stocks with very light volume and especially with spreads more than a couple pennies, your results can become somewhat distorted, e.g. if you are shorting a stock with a bid of $3.50 and ask of $3.70 with a last price of $3.50, and you short 1,000 paper shares on Think or Swim for $3.60 – you are up automatically $100 right off the bat. In real life, the order would not be automatically filled, and with an illiquid stock, your buy or sell order could actually can have real impact on the price of the stock. I paper trade these types of stocks occasionally – I keep this dynamic in mind, and don’t manipulate my orders in my favor. In addition, I have never gotten a partial fill in paper trading – a obstacle sometimes in fasting moving stocks – though not in ones with high volume. However, the good thing is, fills are not automatic in TOS’s platform, the spread average must hit your bid to execute.

5) Short Biased Strategies May Look Different In Real Life: On TOS, the majority of stocks are deemed as “hard to borrow”, even more so than if you were using them with real trades. I’ve heard Interactive Brokers’ paper trading has stocks more accessible to borrow for shorting. To give myself practice shorting gutter stocks, I use the buy function to short and the sell function to cover, and reverse the results. For the last couple months, I used a virtual coin flip to determine if I could find shares to borrow for shorting. Recently, I have used the Interactive Brokers list of shares available to borrow. The point is, not every stock is shortable based on your broker’s inventory and legal restrictions.

6) Be Invested in the Results: Most people’s argument against paper trading is that the emotions are not there. It depends on your psychological make up. To me, its very much the same emotionally. This is because I care way much more about being successful and good at trading then I do about losing a little money. Not to be snobby, but at this stage in my career, a couple thousand dollars is chump change to me. I could lose that much in small positions on my path to learning on how to day trade. You will lose money when your first start out – I can guarantee it. The lucky ones make a little first and then lose their profits in tuition, which is much better than losing money right out of the gate. But why would I pursue that certain fate, when I can create an edge for myself paper trading. Besides anyone that has looked at the risk management statistics, it’s much harder to dig yourself out of a deficit – hence the point of cutting your losers quickly. So if you care very much about how your paper trading goes, and find yourself fearful of entering trades and bailing out of trades way too early, then you may learn a thing or two from paper trading.

7) Get Some Real Trading Experience Early On: Almost in contrast to what I have said previously, I do have a month of real trading under my belt. I’m down $600! Knowing what I know now, it was RETARDED of me to trade the way I was without knowing a thing about stocks. What’s resistance? What’s support? With that said, that experience has helped me out immensely in ensuring my paper trading is realistic – I have something to draw on, to compare it to, and build off of. For newbies, I recommend opening an account at a brokerage that gives you a month of / or 100 free trades (TD Ameritrade or E-Trade). Use those free trades to buy, sell and short small positions (even 100 or 200 shares) with the methodology you plan to employ. After a month of real trading using small positions, you will know if you are ready to trade with the big boys and girls – nobody will have to tell you, you will know. If more learning and experience is in order, this is where I recommend doing paper trading before you go live again.

So for the opposite point of view on this, please see below. I do want to thank Investor’s Live and Lighter for not dismissing paper trading all together:

[Sun Jan 18 18:24:21 EST 2009] MuddyMike wanted to paper trade when he first came to me….

[Sun Jan 18 18:25:18 EST 2009] Muddyi told him nope,i won’t waste my time on that…you got to in realtime with real $…..

[Sun Jan 18 18:25:45 EST 2009] Muddyplay small but plat real…it is not the same ,not even close

[Sun Jan 18 18:26:03 EST 2009] Muddyits baptism under fire…

[Sun Jan 18 18:32:06 EST 2009] lighteri was just going to say i completely agree with Muddy on paper trading. if you’re completely brand new, you can use paper trading to learn basic mechanics, but you won’t start truly learning the market unless you have real money on the line and need to make decisions under pressure. you can play small position size until it clicks in

[Sun Jan 18 18:32:58 EST 2009] InvestorsLiveagree lighter, you also become trigger shy in real life.. afraid to enter/exit which may cause a delayed entry etc

[Sun Jan 18 18:33:33 EST 2009] tortexalpaper trading = playing nintendo vs racing a real car

[Sun Jan 18 18:33:38 EST 2009] InvestorsLivenothing compares to the real thing for sure, but it is good to get the mechanics of it down

[Sun Jan 18 18:33:40 EST 2009] Lauraeasy to fudge on the entries exits with papertrading

[Sun Jan 18 18:33:50 EST 2009] Laurayou say you are being honest………….but come on……….

[Sun Jan 18 18:34:20 EST 2009] LauraThat’s where I WOULD HAVE entered etc.

[Sun Jan 18 18:34:54 EST 2009] InvestorsLiveone thing if you do it.. you can’t use an eraser

[Sun Jan 18 18:37:56 EST 2009] Muddyi’m glad to hear the agreement on paper trading

[Sun Jan 18 18:39:21 EST 2009] Muddythe object at first is really not to try to build your acct because its hard because you should use tiny position sizes

[Sun Jan 18 18:39:37 EST 2009] Muddyits to get the “real” feel

[Sun Jan 18 18:40:08 EST 2009] Muddyeven a few hundred dollar position is way different than paper trading

[Sun Jan 18 18:40:14 EST 2009] Laurathe emotions that go with a trade

[Sun Jan 18 18:40:19 EST 2009] Muddyyup

[Sun Jan 18 18:40:32 EST 2009] Muddyemotions a huge part

[Sun Jan 18 18:40:49 EST 2009] LauraI hope, I wish, I wanna, Arggggggggggggh, I lost a ton

[Sun Jan 18 18:41:07 EST 2009] Muddyimo,play a bunch of stocks….dont push setups though…

[Sun Jan 18 18:41:32 EST 2009] Muddylet them come to you but just go in on ones you see

[Sun Jan 18 18:41:56 EST 2009] Muddyits the fastest way to learn imo”