12 September 2013

Seven Deadly Trading Mistakes - Part Four

Right - we've looked at strategies and planning, so now we're ready to trade right? Wrong! At least, we're not ready to trade live.

Mistake Number Four - Not Testing

Trading is a great business, it offers potential levels of income and freedom that most people can only dream of. So it's quite natural that having got the groundwork out of the way, the novice trader is eager to get clicking those buy and sell buttons and see the profits roll in. But hang on - the preparation isn't over yet!

Imagine for a moment that you decided you wanted to become an airliner pilot. You spent time and effort researching the type of aircraft you were going to pilot, you read some books on how to fly, and one day you found yourself in the cockpit at the end of the runway. Clearly, without having actually taken some time to learn how to fly this machine full of passengers, trying to take off would be a disaster! So why is it so many traders believe they can read a book about trading and then leap into the market without first getting some experience?

If you were going for the pilots job, you'd take a training programme which would undoubtedly see you getting some no-risk experience in a flight simulator. This would give you the opportunity to make all of your early mistakes without crashing a few seriously expensive airplanes in the process.

As traders, we are very fortunate in that we, like airline pilots, can practise and hone our skills in a risk-free environment. Indeed we have the added benefit that we can simulate our activity with high degrees of realism at little or no financial cost at all.

I am of course talking about "paper trading". In the most basic sense of the term, paper trading means that we follow our trading plan exactly as if we were going to put real money into the market, but at the point where we would actually buy or sell, we simply make a note of the current price instead of opening a live trade. We would continue to manage the trade exactly as if we had real money in the market, and would exit accordingly, again writing down the exit price.

Going a step further from pen and paper, today's internet-generation trader can take advantage of software simulators like TSim+, which imitate a live trading platform. These programs have the advantage of making the paper trading experience much more realistic; they also cannot be cheated in the same way as a note on a piece of paper, that is to say we cannot conveniently decide to erase a trade we later decide was a mistake!

There are some who believe that paper trading is not worthwhile as it can never reproduce the emotional stresses that are involved in live trading. Whilst that is true to a certain extent, I would argue that if you are not sufficiently proficient at executing your trading plan in a simulator, why would you be able to do so with real money?

Paper trading gives us a great opportunity to put into practise what we have learnt, test new strategies, and tune our skills with no risk. Once a trader can consistently show a profit on a simulator, they are ready to take the next step - live trading. Again, this is not something to be rushed, and again, like airline pilots we can work our way up to this.

Just as the pilot is probably not going to make his first flight in a jumbo jet, neither do we as traders need to take a full-size trade when we start for real. If trading equities (shares), we can buy and sell very small amounts at almost negligible cost. If trading futures, we can usually start with "mini" contracts which are valued at a fraction of the price of a full size version. Whilst this limits our profit potential as we take our first steps in the live market, it very importantly also limits our potential losses.

With the huge array of software tools available to us, along with discount brokers offering cheap trading instruments, there is no need for any trader to get seriously burned on their first outing into the market.

Action: We must commit to testing and practising our trading in a risk-free environment before putting our capital into the live market. Only when we can show consistent profit on a simulator should we move on to trading real money, and then only in small doses.

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