This is where paper trading is a helpful tool early in the development process. The fact that paper trading does not involve monetary risk makes it psychologically different from live trading. At an early stage of development, however, that is a plus. You are not trying to precisely simulate entries and exits, and your profit/loss (P/L) outcomes are not all-important.
Rather, you’re using paper trading to get a feel for different trading styles and markets. In a sense, during your early, initiation phase as a successful trader, you want to approach paper trading as a video game. See if it’s interesting and challenging. See if it is just plain fun. See if it fits your cognitive and emotional styles. And, yes, see if it offers opportunity.
Many trading platforms offer paper-trading capability, including CQG, NeoTicker, Ninja Trader, e-Signal, and Trading Technologies. For our current purpose, bells and whistles are not important—all you need is a setup that enables you to practice trading and that will track your trades and their P/L. You will want to paper-trade different markets and different trading styles. The combinations of these will expose you to many potential trading niches. If you find that you really dislike a particular market or style, accept that as useful information and try to figure out what turns you off and/or what is missing for you. If something feels right and comes naturally, that will also be instructive. The important thing is to be creative. Try to observe traders, read about them, and imitate them. Cover as many markets and styles as you can. Explore. Play.
How much time will you need to get a feel for any particular trading niche? In the best of all worlds, it would be at least several weeks for active intraday traders and at least several months for those trading longer time frames. Medical students, as I mentioned earlier, take at least six weeks to complete their specialty clinical rotations. This is because they need to have sufficient exposure to a range of treatment settings and patients to truly appreciate what the specialty is like. Similarly, experiencing different kinds of markets—fast ones, slow ones, trending ones—helps you appreciate the nuances of each trading niche. Six weeks’ experience at intraday trading provides you with about 30 days of exposure—probably enough to capture varied market action. Equivalent exposure with a swing-trading approach, where you’re holding positions for several days at a time, might require the better part of half a year.
This may seem like a long preparatory time. The temptation is to shortcircuit the process and jump into live trading and the prospect of making money. Such an attempted shortcut, however, is precisely what generates many emotionally driven performance problems. Look at it this way: Your cognitive and emotional styles will always win out in the end. You will always gravitate to your natural style of processing information, and you will always gravitate to what you find most gratifying. This gravitation will either be planned—taking you in the direction you want to go—or unplanned, subverting what you are trying to accomplish. If you rush your trading development and enter markets without first finding your niche, your most fundamental traits are apt to work against the niche you (artificially) define for yourself. Instead of a multiplier effect, you will generate a divider effect. You’ll be telling yourself to trade one way, and your heart and head will be leaning a totally different way.
I recently interviewed a trader who wanted to come to work at my firm. He had started a training program at another trading house, which went out of business shortly thereafter. In that prior training experience, he was required to develop what he called a “business plan.” Incredibly (to my way of thinking), he composed a 20-plus-page document detailing the market he would trade, how he would trade it, how he would measure his performance, how he would improve his performance, and so on. The idea was that he would then start to work his plan on the company’s trading simulator.
It sounds logical: Develop a plan, practice it in simulation, and then take it live. By now, however, you can see that his firm had it backward. How can the trader develop the best plan for himself if he hasn’t first tried trading (on a simulator or live) and discovered the kinds of trading and markets that best match his abilities and interests? Trading plans are well and good, and business planning is essential to success in any commercial venture. But if you were a bank loan officer or a venture capitalist, would you fund a 20-page business proposal submitted by someone who had no prior business experience? Any plan you develop should emerge from experience—and the opportunities that you observe during that experience.
The kind of experience that will allow you to develop trading plans, Bloom found, is play: trying out different markets and trading styles and observing which ones feel right.
What kind of experience would be helpful in exploring market niches? If I were to recommend a few core experiences to start your paper trading and niche finding, these would be (1) fundamental, longer-term trading of individual stocks; (2) short-term momentum or countertrend trading of equity indices; (3) system trading of a basket of commodities; and (4) relationship trading between related trading instruments (stock sectors, fixed-income instruments of different duration, options of different expirations or strikes, etc.). Your fundamental trading would expose you to the process of researching stocks and industries and acting upon your judgment. Short-term index trading would provide you with experience in making rapid decisions based on shifting intraday supply and demand.
System trading—even something as simple as trading moving-average crossovers on an end-of-day basis—would give you a sense for rule-based trading across multiple instruments. Relationship trading would introduce you to a different way of thinking about market movement and ways of profiting from it.
These are but a few common trading markets and styles, and there are many ways of blending them. For instance, you can engage in spreading on a long-term basis if you think that small-capitalization stocks are in a bull market relative to large-capitalization ones, due to a favorable interest rate environment. This would have you trading the relationship between the Russell 2000 Index and the S&P 500 like a fundamental trader.
Alternatively, you could follow a price chart of the difference between these instruments and trade the spread like a momentum trader. There are system traders who engage in short-term momentum trading, and there are systems for implementing longer-term fundamental market ideas. The permutations of instruments, time frames, and trading approaches are near endless.
Read More : Paper Trading As A Self-Discovery Tool
