Sometime back I came across these interesting lines on Trading. “In Trading, relying on hopium is worse than addiction to opium. Your gains will be nil and your trades typically will result in pandemonium.” Hope is never a profitable trading strategy and hence it becomes paramount for all traders to ensure that they perform robust backtesting to evaluate a strategy’s performance and also conduct paper trading before taking their algorithmic trading strategy live.
This article attempts to cover the paper trading part in the strategy testing process. In our Executive Programme in Algorithmic Trading (EPAT™) we take our course participants through the entire process of building algo strategies. It starts with knowing the basics of financial markets, algorithmic trading, mathematics and statistics, derivatives, programming and trading platforms. Our expert faculty then guides our EPAT™ students to combine this knowledge to build profitable algo trading strategies.
Flowchart of Algo Strategy Creation
The flow chart shown above depicts the process of building a trading strategy. As can be seen in this flowchart, paper trading or virtual trading is an important element in the strategy creation process. The pros of paper trading your algorithmic trading strategy are as follows:
- You don’t have to risk real money
- Test trading strategies without any stress or emotions
- Get to know the different features offered by the trading platform
- Paper trade different types of orders, instruments, markets etc.
- You can compare the backtesting performance of your strategy with the paper trading performance in your choice of programming language.
- You can further optimize your algorithmic trading strategy based on paper trading results
- Verify the robustness of the trading API solution which you’ll be using once you go live.
Virtual trading has certain cons like you cannot ascertain the market impact of your paper trades or the slippage costs that you can incur in live trading which may not be reflected in your paper trades. One needs to be aware of these cons while evaluating the final performance of your paper trading strategy.
Who can benefit from a Paper Trading Account?
Following are the parties who can benefit from a paper trading account.
- Students who are learning algorithmic trading
- Newbie traders who have trading ideas and want to test them before taking them live
- Experienced traders who want to explore their algorithmic strategies in untested markets
How does Paper Trading work?
Some brokers provide a paper trading (virtual trading) environment within the live trading account and you need to select the paper trading feature once you login to your live trading account. This will activate the simulated trading environment. Some other brokers provide paper trading login credentials which are separate from your live trading account.
Paper trading works almost like a live trading account. You get to use most of the order types, trade different instruments and try different features offered in the trading platform.
You might need to configure your paper trading account and may require market data subscriptions or these can be the same as your live trading account. You are provided with a certain amount of equity to facilitate the trades. The value of this equity will wary based on the profit/loss made by the strategy in paper trading. You can also reset this equity value back to the original amount in case you want to trade other new strategies.
Trades entered using paper trading account are not actually executed on any exchange. However, the price of your trade executions will be determined by the real market prices and sizes.
Your broker will provide you with a paper trading account statement at the end of each day which can be accessed from the reports menu.
Brokers with Paper Trading Facility
If you are convinced of the importance of paper trading and have decided to paper trade your algorithmic trading strategies, then ideally your paper trading and live trading platform should be the same. Not all brokers provide a paper trading account. Hence it becomes imperative for you to do so some research before you decide to open a trading account with a particular broker.