I hope you caught my email on Wednesday about FX Hijacker. If you’ve already started testing this strategy, I’d like you to read on …
If you haven’t yet signed up to test FX Hijacker, it’s not too late. Click here http://canonburypublishing.com/hijacker/ to start your trial, but please come back and read this important information …
Today I’d like to explain the right way to test a strategy – and the wrong way …
And how the difference between the two can have a lot to do with your biology!
Do bald men make better traders?
Since the first hairy cave man set off to catch himself a woolly mammoth for his supper, testosterone and risk-taking have been strongly linked.
This month, a report came out that linked financial risk-taking with testosterone levels. Volunteers were asked to choose between a known reward and a gamble between getting a payout (mostly larger than the fixed reward) or nothing.
Overall, the volunteers generally avoided the gamble, even if they would have been better off, on average, by taking a chance. Surprisingly, the biggest risks were taken by people with very high or very low testosterone levels.
The link with low testosterone levels is surprising. High testosterone has always been linked to the traditional image of the trading floor filled with aggressive Wall St traders.
There’s definitely a bravado in trading circles …
Just the other week, I watched two experienced traders tell a novice that paper trading was “for wusses”. Apparently he could learn nothing unless he was risking real cash.
It was a bit like watching the school bullies stick the new boy’s head down the toilet.
I see it again and again on blogs and forums – not sticking people’s heads in the toilet – but talking down paper trading in favour of learning “the hard way”.
So today I’d like to put the testosterone to one side, and take a really balanced look at paper trading …
Paper trading: the case for & against
Back in the old days, paper trading was just that – done on a piece of paper. Fortunately, these days, you can access all the whistles and bells of live trading from demo accounts on your spread-betting platform.
However, demo accounts aren’t exactly the same as live accounts …
The Pros
You can learn the ropes without risking any of your equity.
It provides a relaxed atmosphere for trading which enables you to learn more.
It gives you the freedom to try new strategies and techniques without worrying about the monetary risk of testing new things.
The Cons
Your trades don’t get filled at “live” prices, so you can’t accurately judge the success of a strategy.
You can’t experience the emotions of trading with real money, therefore you can’t gauge your emotional suitability for trading.
As your real money isn’t on the line, you won’t be as focused as a real trader.
Now let’s examine these points more closely …
Can you test a system with paper trading?
There is no doubt that paper trading can be useful if you want to learn how to place trades, and make sure that you’re pressing the right buttons at the right time.
However, detractors will tell you that it’s no good for judging a trading strategy because you don’t get “live” prices on a demo trading account (spread betting companies use a different data feed for their demo accounts).
Your view here will really depend on what it is that you’re testing.
If you’re testing the results for accuracy, then “no” – paper trading won’t give you accurate trading results to match those of a real-money account. However, it can certainly give you a feel for those results – a few points here and there shouldn’t detract from a genuinely successful system.
If, on the other hand, you’re testing your ability to judge trading signals, make decisions, and execute trades in a disciplined manner, then “yes” – paper trading can give you all that.
Can paper trading replicate the “cut and thrust” of the market?
Paper trading takes away the monetary risk from trading.
Those opposed to paper trading will say that without that monetary risk, you’re not accurately replicating the art of trading.
However, it’s worth remembering that there’s more at risk when you trade than merely money …
I’m talking about ego.
Learning to manage our self-esteem, fears and greed without cash getting in the way can be very helpful.
Of course, you can’t recreate the feeling of watching your real-money portfolio getting a hammering by a run of losing trades, but I have spoken to many paper traders who are extremely proud of results they’ve achieved with their demo accounts, and nurture those funds as closely as a live trading account.
If you’re struggling to “care” enough about your demo account – get competitive. Challenge another trader to better your results. It’s a great way to motivate yourself.
How to make paper trading relevant & useful
Paper trading can be a highly valuable experience. It can also be a complete waste of your time and energy. Which of these it is for you depends on your approach to it.
If you can avoid the two pitfalls that I list below, then you should be able to keep your paper trading on the straight and narrow.
1. Many traders take advantage of there being no money at risk and do things they would never consider doing with real money. Don’t use your demo account to develop bad habits. If this is your approach to paper trading, you might as well be playing computer games.
2. Many traders will assume that if they can paper trade profitably, they will automatically be able to make money when they come to real trading. They then jump from demo trading to relatively high stakes when they start trading for real. Paper trading is a route to trading proficiency NOT to trading profitability. Use your demo account to develop your trading techniques and to test out new strategies. Then, and only then, you can begin live testing to judge profitability with live prices.
Moving on from paper trading
Fortunately, there’s no need to jump in at the deep end as soon as you’re ready to move on from paper trading. Plenty of trading platforms allow you to trade for less than £1/point, which means that you can start slowly while you gain confidence in the profitability of your strategy.
This allows you to test the system with live prices, and to judge your own performance under the increased pressure of risking real hard-earned cash.
In the next seven days …
For the UK, next week we can expect to see falling house prices from the Nationwide index and weak retail sales from the CBI survey on Wednesday, set against strong manufacturing expansion from the purchasing managers survey on Friday.
Over the Atlantic, we can see a good example what happens in a manufacturing-led recovery on Friday with the non-farm figures – i.e. very poor job creation.
On the political front, Tuesday will see Britain host an international conference to discuss progress on military intervention in Libya.
Until next week,
