Trading Psychology And Becoming A Real Money Trader

In this hub, I am going to discuss the impact of trading psychology on becoming a trader.  This is going to be done in the context of learning your method basics, and then starting as a real money trader, instead of as a paper trader, and how trading psychology can be related to the outcome.

When you begin trading, you may have some idea of how much you have learned about your trading method, but you in no way have any idea about the mental side of trading, or the implications that trading psychology could have on actually trading what you have learned.

Whether paper trading is important, to an aspiring trader as they progress to real money trading, is a widely debated question.  There are two basic opinions to this:  (1) if you can’t make money paper trading, then you aren’t going to be able to be profitable real money trading (2) it doesn’t matter whether you can make money paper trading, the money and risk is not real so there will be no relationship to real money trading.

I will talk about this further below, but I want to talk about my beginner as a trader first.  I started to learn how to trade in 1995, a time where there was very little available in terms of online trading resources or services to learn from – this was in the 14.4k dial up modem days, and actually netscape hadn’t been released yet.

I met a money manager who was providing a fax and phone hotline service for trading options, which I was already doing, and for trading the sp500 futures index.  Along with this there were two live seminars that were done each year.  Well, I was brand new at futures trading, attending my first seminar, and what was one of the first things that I heard?  Paper trading is for ‘pussies’ – you learn to trade by starting with one contract, and with real money.

Hey, no problem, I can do that, and you can too. Trade real money, when you don’t really know what you are doing and certainly aren’t prepared for, then not only lose a lot of the money, but also take a big hit mentally that you don’t know what you are doing and that you shouldn’t be doing this. 

What happens next, assuming that you don’t quit altogether?  You go from real money to paper trading, but not to learn how to trade and come back to real money, but because of your experiences that have also created many trading related fears that are going to be with you in the future.  Or in other words, no matter how well you learn your trading method and become capable of trading it, this ability may be offset from trading psychology resulting from your previous experiences – where when you would think about trading real money again, you would focus on what happened previously instead of what you know now, and that fear can keep you from trying it.

And what was even worse in my case was that I also lost confidence in my option trading, and I had been doing well with that, which was probably why I was willing to trade futures with real money so soon.  This also happens to people all the time who might not have any related trading experience, but that have done something else very well, and just figured it would transfer over to being able to trade.

Think about this, there is no logical conclusion that because I am a successful doctor, I will therefore be a profitable trader.  This was my beginning attitude too; key word beginning.  I was a scholarship athlete that also had an A average in school, and then I had started and ran two successful businesses.  I later began to lose interest in the businesses and sold them.  Trading was just going to be something else that I was going to be able to do well – not because I was going to be a good trader, but because I had done well at most other things.

I want to discuss some of the common attitudes about paper trading, and why this is not of much use; I am going to do this based on my experiences after a become a profitable trader and also began teaching trading.

Consider:  when you paper trade with a simulator, your fill prices are not real or what you will get with real money.

Even if this is correct, what difference does this make for learning to trade and gain experience with real time decision making and execution.  So some of your prices are off by a tick, does that really matter except to someone who wants to be a scalper where every tick is critical.  Besides being the hardest type of trading mentally, this is not something that I could see a beginning trader doing.  That is a time where you want to focus on the ‘core’ of your method and the ‘best’ setups that it provides.  This is not a time where you want to see how many trades you can take and how fast you can take them, and for this simulator fill prices are not an issue.

Consider:  the trades are being done with no risk.  There may not be any monetary risk when you paper trade, but interestingly, I haven’t seen as many profitable paper traders as would be anticipated.  What is the reason for this, if paper trading with risk is such an easy thing to do?

Risk is only being thought of as financial risk; this is not the only type of risk encountered with trading, and is what makes trading psychology such an issue.  Risks to your ego and self-esteem, and fear of failure are very much involved with trading.  Take a highly successful person and have them struggle with trading, especially paper trading that is supposed to be risk free and even easy to do, and they just aren’t going to have the experience with getting through this.

Yes, there is definitely risk involved with paper trading.  And even if the only risks were financial, wouldn’t it only be prudent to have the confidence of knowing you could paper trade profitably before doing it with real money, regardless of how able you are to afford the losses?  As well, it would be hard to envision a losing paper trader being a profitable real money trader.

Consider:  there is no emotion involved with paper trading.  I was in our chat room and watching a paper trader that was posting their trades so I could give them feedback.  I clearly noticed that they weren’t doing anything; that ‘base’ method setups weren’t being traded.  When I asked about this, I was told that they were up for the day and didn’t want to risk those profits.

Profits – what profits, these are paper trades – there aren’t any profits.  If that isn’t emotion, then what is it?  Paper trading has become very real to the person, as their paper profits have transferred to their ego as a sign that they are doing something well.  Now risk those paper profits, and also risk not doing well, is a risk that this person wouldn’t take.  They never considered that they should have made 2-3 times more than they had, and had the additional learning experiences doing this.  No, they were profitable and they were done. 

This is another example of the interrelationship between trading psychology and trading, even if it is paper trading, and one that paper trading can become very useful for encountering and working through.  The particular person that I am speaking of never has been able to become a real money trader, and they usually aren’t profitable as a paper trader either. 

These are some examples of things that are typically said as reasons for why paper trading is not of value; I could give many more stories and examples for how this just isn’t the case.  Paper trading is not that easy, and is certainly not without risk or emotion.  This is actually a very good thing, because paper trading is the time when you want to become aware of anything that you will have to deal with when real money trading.

I have two problems with paper trading, but this is with the person’s approach and usage of paper trading, and now with paper trading itself.

(1) People take advantage of there being no money risk, and do things that they would never consider doing with real money.  I liken this to playing a simulator like a pinball machine – lose on a paper trade and no big deal, I will just play another game.

(2) People view paper trading profitability, instead trading method proficiency, for an indication of whether they are ready to real money trade.  If your average trade should have made 20 ticks, but you only made 5 ticks because you keep jumping out of trades too soon to save the profit.  Or, if you should have taken 8 trades, but you only took 2 of them.  Then you may have some minimal paper profits, but you have not trade your method at all close for what it should have provided, and this is an indication that real money shouldn’t be traded yet.

Don’t allow yourself to make this into a game, supposedly because there is no risk.  There is huge risk coming from making bad habits, and that is exactly what is being done.  And it doesn’t matter what we may be talking about, changing bad habits that are being practiced every day, would have to be one of the hardest things that a person could have to change.

After I got started and had my introduction to trading psychology and the realities of real money trading, I never thought that I would ever make a dime trading.  And I certainly never thought I would be making my living as a trader, or ever become involved with teaching other people to trade.

Was this a result of learning about trading psychology, starting over and doing so first as a paper trader with a plan on how to properly trade method and transition into real money –vs- jumping into the deep water to learn how to swim?  I suppose it would be too simplistic to just give this for the reason, but certainly it was related and something that I very much wish that I had known about from the beginning, and had done things completely differently, along with reducing a lot of pain.

So, I understand the pros and cons about paper trading, but I also understand its function in becoming a real money trader and how trading psychology is related.  Therefore, not only do I think that paper trading is beneficial, I also think that it is necessary.  However, like most anything else that we do, the value received will be dependent upon the person’s approach and attitude for how it is used.