Paper trading for beginners

What are paper trading and the benefits of paper trading?

Paper trading is nothing but trading with pen and paper without actually entering into any monetary transaction.  In paper trading, you test your knowledge,  understanding the accuracy and performance of your trading strategy.  Instead of actually buying and selling currency you decided to trade, you actually mark the entry price in your notebook,  as the market touches the entry price and mark the termination of the trade, either profit booked or stop loss hit on the same paper. This trading record will tell you how your trading strategies working and how effective are you in initiating trade using your currency pair selection methods.

you can at least spend a few weeks paper trading before you go live with real money and time to familiarise yourself with your currency pairs selection methods. After learning this technique you should open a trading account in the demo, then watch the real-time price action of your selected currency pairs to spot buy signals as per your technique. If the price action gives a buy signal you should initiate a Trade on paper by writing down the exact entry price, exit price, and stop-loss price and open the same trade-in demo account,  After finishing the trade you should also write down whether you have made profit or loss on that trade.  For every trade, you should also write down your comments on the trade regarding how you have identified buy signal, How you have classified that buy signal,  (as a strong signal or medium), if it ended in profit, what you have learned from that trade and if it ended in loss what you have learned from that trade.

In paper trading, the impact of fear and other emotions will be very minimal since there is no money involved. Naturally, you will be very confident while paper trading when compared to real trading. This results in a high success ratio. So, even if you have come out with a high success ratio in paper trading, you then invest decent capital in the real trading account during the first few weeks and after earning profits you can invest large capital to earn more profits.

THE IMPACT OF PROBABILITY AND DRAWDOWNS

ON DAY TRADING

As Day traders we are attempting to make only high probability trades. In other words, we only want to trade when we believe the odds are in our favor. If we want to take advantage of the probability factor, we should not change our trading strategies depending on profit or loss on individual trades. Whether we make profit or loss if we trade in a systematic and disciplined manner, we will still be in the game till the end until we book profits, even if we incur losses continuously in the first few trades.

Now we will understand how the probability factor affects our trading by analyzing the individual and weekly results of two weeks in the form of a small statement.

DETAILS OF TRADING RESULTS FOR the FIRST WEEK:

TRADING DAYS	No of Traders	No of wins	No of Lose
Monday	2	1	1
Tuesday	4	3	1
Wednesday	6	4	2
Thursday	8	6	2
Friday	10	7	3

DETAILS OF TRADING RESULTS FOR the SECOND WEEK:

TRADING DAYS	No of Traders	No of wins	No of Lose
Monday	2	0	2
Tuesday	4	0	4
Wednesday	6	4	2
Thursday	8	8	0
Friday	10	9	1

If we compare the results of two weeks, we will find that at the end of every week we got profit in 21 trades and we incurred loss in 9 trades on average out of a total of 30 trades every week. Our percentage of success for every week is 70%.

When we compare individual trades, we will find that we incurred loss in all our trades on both Monday and Tuesday in the second week. Since we have proceeded with our trading strategy without changing or modifying it even after incurring a loss in all trades for two days, again from Wednesday onwards the odds turned in our favor and we finally finished the 2nd week with our regular success rate.

So, it is very very important that if we want to take advantage of the probability factor, we should not change our trading strategies depending on profit or loss on individual trades. Whether we make profit or loss if we trade in an asymmetric and disciplined manner, we will still be in the game till the end until we book profits, even if we incur losses continuously in the first few trades.

Another important point in this probability analysis is to realize that regardless of the system or method you use to trade there will be occasions when you have losses or even a string of losses. When these losses occur, it is important to have faith in your day trading technique and you should not lose faith or you should not change your trading techniques or methods depending on loss of profits you earn on individual trades.

The final point to be made in the above analysis is that as we can see from the above examples, any trading techniques or methods will go through tough times when it has more losses than wins. There is where money management comes in to play. You should follow strict money management principles that help you to stay in trading even if you incur losses continuously in all trades for a few days. So if you want to take complete advantage probability factor, you should also follow strict money management techniques like following strict stop losses to keep all your losses small and utilizing only little multiple exposures on your margin money depending upon your trading methods, etc.,

DRAWDOWN:

Drawdown is a frightening word in day trading. But everyday trader will experience some drawdown. In day trading, drawdowns are simply unavoidable. We can define drawdowns as the percentage of the money we lose from our capital after finishing a trade. For example, if you start day trading with a capital of $1500 and a few trades if you lose $300 your drawdown would be 20%.

Now let’s say you make more trades and gain $600 which brings you to $1800($1200+$600 = $1800). After this on the next trade, you lose $300. Now your drawdown would be 16.7% (percentage of $300 in $1800). The $1800 was your equity peak as that was the highest point in the period we looked at. The maximum drawdown is the lowest point your account reaches between equity peaks in a given period. For example, if you started your account with $1500 and the lowest amount you had in your account over a six month period was $750, then you had a 50% drawdown. You would need to make $750 from the lowest point in order to get back to break even.

MEASURING DRAWDOWN RECOVERY :

The detailed table below shows how much percentage of profit you require to recover a given percentage of drawdown.

Loss of Capital in Percentage	Percentage of Profit required to recover break even.
10%	11.11 %
20%	25%
30%	42.86%
40%	66.67%
50%	100%
60%	150%
70%	233%
80%	400%
90%	900%
100%	Blowout

Drawdown recovery can confuse many traders. If a trader loses 20% of his account he thinks he needs to make 20% in order to get back to breakeven. This is in fact not true. If you started with $1500 and lost $300 (20%), you would need to make 25% in order to get back to breakeven. If you calculate $300 as a percentage of $1200 (not the original of $1500) it works out to 25%. As drawdown increases, the amount you need also increases. Now you must be aware that following strict money management techniques is as important if not more important than your trading technique or trading system!

To reduce drawdown in your trading career, you should concentrate on two important things. One is following strict risk management techniques and the other is following strict money management techniques.

In risk management, you should follow strict stop-loss levels. You should minimize your losses by following strict stops and you should exit from a trade with a small loss if the trade goes against your expectation. If you stop, then you will be able to identify your risk.

In money management, you should not utilize too many multiple exposures on your margin money. If you use your multiple exposures on your margin money, the drawdown will multiply as per the rate of your multiple exposures. Suppose if you use 5 times multiple exposures on your margin and if you incur a 4% loss on that trade, the drawdown would be 20% (4 x 5 = 20).

If you habitually utilize 5 times multiple exposures and if you incur 4% loss continuously in 5 trades, you will lose all your capital and you will be thrown out of business. Even if you incur loss continuously in 3 trades, the drawdown would be 60% and you will be in do or die position to earn more than 150% of the profit on your remaining capital to simply get back to break even. So, you should plan your money management in such a way that even if you continuously incur a loss in 20 trades one after the other, you should be in a position to stay in the game till the end until you book profits, even if you incur loss continuously in twenty trades.

You should always remember that following strict risk management techniques and money management techniques is more important than following profitable day trading techniques and stock selection methods to earn profits in day trading. You should only risk a small portion, again repeat a small portion of your trading capital in one trade.