By Owen Trimball
Option paper trading is a term used to describe the way we would test an option trading system without employing real money. There are several major benefits from doing this.
1. You get to prove to yourself whether the system you’ve chosen or been trained in, is actually, a profitable one. Additionally, it permits you the means to tweak and improve the system and determine the financial consequences without any actual exposure to risk. This can give you a belief in the system itself.
2. The process of option paper trading “trains” you how to react to adverse market conditions. A component of any worthwhile options trading system is the assmption that a percentage of trades will be losing ones. You must be psychologically prepared for this. Where a predetermined stop loss is a component of your system you will need practice in accepting losing trades before you decide to use your own capital.
3. The most successful options traders claim that 90 percent of trading success is about psychology. You need the right mindset when making trading decisions. If you assume the mindset of a gambler, you will feel the pain of gambling losses. It is crucial that you look at your trading with the mindset of a serious business person. On a daily basis you’ll make business decisions according to strict criteria. You will need to have patience and wait for the right setups and confirmation signals so that you don’t make the mistake of trying to anticipate the market before it shows you where it’s going.
You will have to practice how you manage your trading capital and use position sizing in a methodical way so you don’t risk too much of your money on any one trade. You may need to make some blunders in this area and “feel” the consequences of greed or unnecessary risk. Option paper trading is not merely about discovering trading opportunities, but also about learning the self discipline that’s so necessary in order to succeed.
How and where to Paper Trade
Typically the most popular options brokers such as TradeKing, OptionsXpress and ThinkorSwim, include an attractive feature that enables you to paper trade without resorting to real money. They provide you a “Paper Trading” tool, where live options prices are applied to live stock prices and you can try out your trading strategies without risking real money. But the rest is real, including trading reports which keep a record of all your deals and brokerage costs, so that you can see what your profit or loss would have been, had you been trading with your own personal funds.
Just add an imaginary amount of money to begin with and then proceed with implementing your trading plan. This is an excellent way to gain real confidence that you can actually make a living trading options.
One last thought. Option paper trading must be taken seriously for it to be truly effective. A casual approach which neglects to monitor your trades or enters questionable positions knowing that you can’t really lose, is a dangerous psychology. Trust me, when you graduate to using real money, all things will change at an emotional level … so to make use of it as a serious training ground and you will be rewarded.
Owen has traded options for many years and is writes for “Options Trading Mastery” – a popular site that explores the best Option Trading Strategies including the popular Iron Condor.