"Doesn't paper trading accomplish the same thing as trading live but small?"
By Dave Mabe
Here's a question from Rick H., who is working through my Better Backtesting course. (Name used with permission; edited for clarity.)
Rick H.
In lesson 4 on moving from backtesting to live trading, wouldn't paper trading accomplish the same thing?
Dave:
Great question!
While paper trading is underrated among most traders, it's not a substitute for trading small with real money.
I look at paper trading as accomplishing a very important thing:
Seeing how trades in your backtest play out in real time.
There is something about watching the candles form and the orders happen that bridges the gap between the theoretical and reality.
If you have any future leak in your backtest, it will clearly show up in paper trading (without risking a dime).
Understanding how your backtest translates to real-time trading is incredibly important.
This is a big reason why being stuck in "backtest world" can be such a waste of time.
You can spend a lot of time optimizing a backtest that has future leak.
You get your hopes up and then bam - the market quickly tells you how incorrect your assumptions were.
So what does trading live with small size accomplish? (I sometimes call this "pilot trading" from my woodworking days and drilling "pilot holes" for screws in hardwood)
This is where the theoretical rubber hits the road.
How do the actual trades in your strategy get filled?
How much slippage is there?
Are the entry prices in the backtest realistic or too optimistic?
These are the important questions for determining whether your strategy will work.
And you have to use live money to get the answers.
The good news is that you can use tiny amounts of money to get the answers you need.
Think about this phase as getting feedback from the best traders in the world in real-time - because that's what it is.
Great question, Rick, since this is probably the most underrated topic in systematic trading.
-Dave
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