Dec 22, 2023
Written by:
John McDowell
Cryptocurrency paper trading is a relatively new experience with very few apps offering this service. While nothing new to the world of equities and futures, crypto simulation offers an opportunity for traders to test strategies in a risk-free environment.
The psychology of trading is one of the most important aspects of trading, aside from mastering technical analysis, fundamentals, and other factors. Understanding your emotional swings, controlling your impulses, and remaining calm and resilient during profit and loss is the key to unlocking your true potential in the markets.
To that end, there are many differences between paper trading and trading real crypto. In this guide, we'll discuss the purpose of paper trading and how you can use it to your advantage when preparing to become a profitable crypto trader.
As with any trading instrument, psychology and discipline are paramount to maintaining a positive equity curve. While have all the wisdom in the world for technical analysis can be beneficial, and having a trading plan is crucial, none of that matters if you lack the emotional intelligence to execute well.
In crypto trading, you will face unique psychological challenges in that the crypto market is far and away more volatile than most other asset classes. The price fluctuations are often violent compared to something like stocks or indexes. This, of course, is relevant to the season and the type of correction or growth phase.
In addition, depending on the type of trader you are -- long or short-term -- you'll face considerable pressure to sell as bear markets can exceed 50% of the value gained in bull markets.
Here are some tips we recommend when dealing with crypto trading psychology:
The emotions in paper trading aren't the same as when using real money. That's the oft-assumed answer. However, to the dedicated and purposeful trader, the emotional canvas inside paper trading will still be explored in such a way that it will impact your real trading experience.
As with any performance sport, training outside the ring is where the battle is won or lost. It is in a simulated environment that we can observe, practice, and anticipate the moves of the market without the pain or pressure of the real conflict. Yet, the best traders will use this opportunity to channel the inner conflicts they will expect when real money is on the line.
In one of our interviews with Dr. Brett Steenbarger, Ph.D. we gained valuable insight into this process. Listen to what Dr. Steenbarger has to say about paper trading emotions:
Having a plan in the calm of the moment is different from maintaining and acting on the plan once we get punched in the nose!
That doesn’t make simulated trading worthless, however. Even the best boxers practice in the ring away from formal competition to work on their movement, their combinations, etc. Similarly, basketball teams prepare for the next game by scouting the opponent and then practicing against the offense and defense that the opponent are likely to use.
And, of course, where would a Broadway actress or actor be without practicing lines away from the distraction of crowds.
That is what simulation accomplishes in trading. If we can’t be consistently successful in simulation mode, how in hell are we going to succeed with the pressures of real-time P/L??
Once we establish our consistency in sim, then, of course, we want to go live and tackle the pressures of actual gains and losses. This is why musicians and theater professionals conduct dress rehearsals. Simulation/practice is necessary for development, but not sufficient.
It’s a step in the learning process.
The end goal is always to transition from simulated trading to real trading, but this process shouldn't be cut and dry. Imagine if Lebron James turned pro and then never practiced again. There's no way he would be the best basketball player in the NBA. Likewise, if you want to be the best crypto trader, consistent practice is a must.
Markets are ever-changing. Yet, sometimes, they rhyme with past markets. For this reason, simulated trading often holds the key to mastering new and current market trends. But how are you going to know how to perform and what's working well if you don't study the past under similar circumstances and conditions? You're gambling, at best.
For that reason, transitioning to real trading should be a process that allows you to go back and forth between the two. Even the most seasoned traders will enter the simulated trading world to hone and update their skills. Let it complement your trading journey by remaining a part of your growth process.
Knowing that the volatility of crypto markets can affect your emotions and ability to make sound decisions, let's take a look at 5 major differences between real and simulated trading:
Understanding the subtle nuances between real and simulated trading is a crucial component to becoming a seasoned trader. While paper trading cannot fully prepare you for the type of emotions you'll experience, if you treat it seriously, you'll have a firm foundation to fall back on when your emotions rise.
Behavioral finance theory is the integration of psychological principles into financial decision-making, recognizing that traders often deviate from rational behavior. In the crypto realm, where market sentiment plays a pivotal role, understanding these concepts could help with trade and risk management.
Several emotional biases can cloud judgment and affect the behavior of crypto investors. In turn, these biases may alter the price projection of a particular asset or instrument. Let's take a look at a handful of the more common biases and how they can influence your trading.
Overconfidence Bias:
Loss Aversion:
Confirmation Bias:
Herding Behavior:
Recency Bias:
Awareness of these biases is the first step in becoming a more mature trader. On the internet and social media, influencers and crypto-believers abound. Often they contribute to the biases we've mentioned above. In paper trading, you gain power over these biases by conducting your own observations, analysis, and strategies, thereby enhancing your decision-making processes.
Perhaps the most important aspect in trading, in general, understanding and respecting risk management is paramount to your success as a crypto trader and investor. This applies to both real and paper trading accounts. There is an old adage in trading that you must cut your losses quickly. We would add that you mustn't enter a trade without knowing where you'll exit.
Setting and sticking to your risk management strategy is the best way to preserve your capital. One thing is certain in trading, you'll never win 100% of the time. In fact, you'll likely lose most of the time. Yet, with proper risk management and the ability to hold onto winners, you'll far exceed your losses in the end. It's all a numbers game.
In addition to managing risk, you would also do well to understand the risks involved with fraud and other factors influencing the crypto market. As with the recent FTX debacle, the crypto space is not nearly as regulated and stable as the stock market. Be sure to do your due diligence and never put all your eggs in one basket when trading crypto.
While many would consider the behavior of crypto irrational, it may actually be more pure than other manipulated markets. It is for the reason of herd mentality that we often see speculative bubbles in issues like Bitcoin. As most participants follow social sentiment for their decision-making, coupled with a finite number of coins, as it were, crypto markets suffer violent swings.
Yet, these swings are not without reason. Without the "stabilization" of central banks, ETFs, futures, and other derivatives, what you might be witnessing is an unadulterated version of price action. Depending on your preferences and ability to understand market dynamics, this may play to your strengths.
In order to adapt to this dynamic and often volatile nature of crypto, we recommend nothing more than time spent in the simulator observing trends. Couple that with a firm foundation in pure technical analysis like the Wyckoff Method, and you may find yourself a strategy or two worth exploiting.
Entire books have been written about trading discipline, and they all can be applied to crypto trading as with any other asset class. Trading discipline is more of a journey than most people are willing to travel. It never ends.
Some of the greatest traders in history have blown up their accounts late in life, while others never make it past the first few months or years of trading. It's constant process that depends heavily on risk management and impulse control. For a solid list of trading psychology books, here are a few of our faves:
Our favorite, hands down, is Dr. Steenbarger. He's a prolific trading psychology author, speaker, and coach. With almost 5000 articles on his blog and numerous books published, he knows a thing or two about trading discipline. One of our favorite quotes from him can easily be applied to crypto trading:
The key to sustaining discipline is to identify the specific short-term needs that are occasionally overshadowing trading rules. Traders who overtrade, for example, often have problems during quiet market times. Their needs are for stimulation. By creating stimulating activities during the trading day that don’t take them away from their screens, they can avoid using unwanted market activity as their stimulation. Dr. Brett Steenbarger, Ph.D
Steenbarger often cites that we become "what we consistently do." To that end, practicing in a simulator to overcome bad habits and replace them with positive ones is the best place to start.
We hope you see the importance of crypto paper trading by now. As we've noted, the most important aspects of paper trading are the need to observe, practice, and develop positive psychological habits. In addition, crypto simulators give you an ongoing tool for refining your live trading process. Let's recap a few important points:
These are a great starting point for achieving mastery in crypto trading, and the first step to success in through the use of a simulator.
At TradingSim, we offer one of only a few crypto trading simulators that allows you to trade with true market replay. Additionally, we provide you tools for charting, trading and performance review, and customizable interfaces. If you're looking to get into crypto trading, but need an affordable means to testing the market and defining your strategies, look no further.
If you harbor multiple traders within you–some careful, some impulsive, some successful, some losing–your first task is to avoid labeling these traders and instead take an Observing stance. You need to figure out why these lousy traders within you are trading! The chances are good that they are trading to achieve something other than a good return on equity: a sense of excitement, a feeling of self-esteem, or an imposed self-image.
True deliberate practice is a significant predictor of success.
Dr. Brett Steenbarger, Ph.D
Tags: Paper Trading
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