Before getting to the meat of this week's article, I have to say I was amazed and humbled by the sheer number of positive emails I received about last weekend's article. Thank you. Only one email so far was negative and that from someone who admittedly did not read the article but who was offended because I entitled the article: "Lots of Ways to Skin a Cat." Let it be known that I do not really advocate skinning cats. It is an old expression not to be taken literally.

Anyway, I digress. I frequently do get very helpful suggestions in emails and one I received was from a subscriber in the stock brokerage industry who, among his many insightful comments, suggested that he never understood why paper trading was so frequently recommended because it is definitely different when real money is traded. He is absolutely right that things are very different when real money is placed at risk as I'll discuss below.

I am an advocate of paper trading, but not because it is the same as putting real money at risk. Paper trading has its place, and, in my opinion, that place is a continuation of a trader or would-be trader's education. Paper trading is simply practicing strategies without using real money. Nothing is at risk and it costs nothing but time. Practice trading, if done properly, helps the trader learn the strategy he is practicing better. Nuances can be discovered without taking financial hits. The practice trader can learn, for example, how and when to adjust option positions or how and when to take profits. It can be an aid in discovering how to cut losses and let profits run unemotionally. For me, those are the primary benefits of paper trading. Though I have been trading real money for many years now, I still paper trade when I am examining a strategy with which I am not completely familiar.

However, I am in complete agreement with my broker-subscriber who says that paper trading is not the same as putting real money at risk. It isn't!!! When someone paper trades, it is not likely that the heart will beat faster or the lump will come up in the throat. There are no sweaty palms in paper trading. Real money trading is a different story and I know of no way to replicate real money emotions when paper trading. Placing real money at risk does bring fear and greed to the surface. Those emotions create the next and extremely critical battle the successful trader must face on the road to success. The goal is to trade without emotion because the emotional trader is the trader least likely to succeed. Perhaps completely unemotional trading is unattainable, but I am convinced that those traders who succeed are those who have the emotions under some control, who have tight discipline in their trading, and who discipline their money management.

I suspect that intimate knowledge of a strategy gained earlier through paper trading helps a trader control emotion though it does not win the battle. I have seen a number of successful paper traders go down in flames when it came to real money trading. When asked what happened, they have universally told me that when they started using real money they stopped doing what they had been while paper trading. They abandoned their business plan, they did not follow their exit strategy; in short, they let their emotions rule.

The ultimate goal, I believe, for the successful trader is to trade with discipline and as little emotion as possible. Paper trading can be extremely helpful, but it is only a part of the puzzle.

Good Trading!
Bill Kraft

November 24, 2007

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