Simulate Your Day Trading Strategy before Taking It to Market - dummies

Simulate Your Day Trading Strategy before Taking It to Market

With a backtested strategy in hand, you may be tempted to start putting real money on the line. Don’t, at least not yet. Start with what is known variously as ghost trading, paper trading, and simulation trading.

Sit down in front of your computer screen and start watching the price quotes. When you see your ideal entry point, write it down. When you see your exit point, write it down. (Or use the simulation functions available from brokers.) Do exactly what you plan to do with real money, just don’t use the money. Then figure out what your performance would have been.

If your strategy doesn’t generate a lot of trades, you can probably keep track with a pen and paper and then enter the data into a spreadsheet to calculate the effects of commissions and leverage and to analyze the performance on both a percentage and a win-loss basis. How does it look?

For more complex strategies that involve a large number of trades on a large number of securities, you may want to use a trading simulation software package. These packages mimic trading software (and are usually added features to trading software packages). They let you enter the size of your order, let you use leverage, and tell you whether your trade can be executed given current market conditions.

Markets are affected by supply and demand, and your trade can affect that, which is the biggest drawback of simulation trading: It’s difficult to take the market effects of your trade into account in any reliable way, especially if you’ll be trading large positions in thinly traded markets.

The results of your trading simulation can help you refine your trading strategy further. Does it work in current market conditions? Are you able to identify entry and exit points? Can you execute enough trades to make your day trading efforts financially worthwhile? Do you want to refine your strategy some more, or are you ready to go with it?

Your tests won’t guarantee your results, and they won’t show you how you’ll react under the real pressure of real markets and real money. However, if your system doesn’t work well under perfect conditions, it is unlikely to do better in actual conditions.

Finding a suitable strategy may take a long time. Some traders report spending months finding a strategy they felt comfortable using. Day trading is a business like any other.

Consider this part of the market research and education process that you need to go through, just as you’d spend time doing research before opening a store or training for a new career. Be patient. It’s better to do good simulation for months than to lose thousands of real dollars in hours.