Why Not Paper Trade?

It occurred to me that anyone who read yesterday's post would not be out of line to ask why I didn't 'paper trade' for a time before committing real money to the market. For anyone unfamiliar with the term, paper trading is a fancy way of saying 'pretend.' You simply track your pretend buys and sells, with the idea being that you can determine if your trading method is viable. It would certainly seem I could've saved myself a great deal of money if I'd practiced before putting my money on the line.


The problem is, it just doesn't work.

As I've discussed frequently on this blog, management of emotion is one of the key traits that ends up separating the successful traders from the also-rans. When the market is in an uptrend, three out of four stocks will go up in price. We're all geniuses with those odds. Once we hold a stock though, that's when the emotions start to cloud the judgement.

What if the stock drops five or six percent below my purchase price? Do I cut my losses and move on, or wait to see if it will come back? If I sell and it comes back, how will that affect my thinking next time I'm in a similar position?

What if a stock I own advances 15% quickly? Should I sell and take my gains, or is this a winner that I should hold onto?

Even with the predefined set of trading rules I adhere to, trading on paper cannot possibly replicate the feelings that accompany having money in the stock market. There is exhilaration when a stock launches 9% in one day, and despair when it drops 10% another day.

As I've posted on this site, I currently own (SOL) and (SOHU). If you take a look at the charts, you can see that each of them advanced over 20% from a buy point recently only to return within 5% of it a week or two later on high volume. Only through having actual money on the line could I experience the fear of watching huge gains evaporate like this. Self doubt tried to creep in, I wondered if I was wrong again in my picks, as I'd been so often before. There is no way to fake this - only by living the experience can one learn to combat the emotions and develop the discipline necessary to trade effectively in spite of them.

I held both of these stocks through this shakeout period, and today they are both over 20% above my purchase price. Of course that could all change tomorrow, but the point is over time I've learned to put the emotions to the side and trade within my rules. I believe I have to do this if I want to have any sustained success in the market.

-Geoff