Warrants paper trading
What is paper trading?
Paper trading is a process in which you make investment decisions without committing real money.
You approach a paper trade just as you would a real trade, taking into account everything you would consider if you were making a real investment, and recording your investment decisions on paper. By looking at how your theoretical investments perform you can evaluate how well your investment approach is working, without the pressures of possible financial loss.
Why paper trade?
Paper trading gives you the opportunity to practise, and learn, without the danger of real losses. You can experiment with different trading approaches, and test and refine your trading strategies in practice before applying them in the market. You can observe how warrant prices move, and get a feel for the effects of time decay.
It is also easier for you to be objective in a simulated trading environment than in the real market. When you have real money at stake, emotional reactions can sometimes cloud your judgement. However, if you practise a detached and objective approach during the paper trading stage, you may increase your chances of using such an approach in real trading.
How to paper trade
You should approach paper trading as realistically as possible. Just as you would if you were trading real money, you need to take into account:
- your financial resources
- the amount of time you can realistically dedicate to trading
- your desired exposure to risk
Having formed a view on the market, or a particular stock, you choose a warrant to buy that will reflect your view. You then theoretically ‘buy’ your warrants, and record the details of the trade, just as you would with a real trade.
On ‘selling’ your warrant, all details should again be recorded and the profit or loss from the trade calculated. If you are testing several different strategies simultaneously, the results from the strategies can be compared.
Your overall aim is to test the approaches to trading that you are considering. You should set out, in writing, one or more trading plans. The plan should include details such as:
- profit targets
- the degree of loss that will trigger an exit from your position, and
- other parameters that define your desired risk/reward profile
Each time you examine your position, ensure that the action you take is in accordance with your trading plan.
You will need a source of pricing information so that you can record your trades at market prices. Possible sources of pricing information are:
- tables of warrant prices in the financial press
- free warrant prices, either live or delayed, on the internet
- warrant prices from an information vendor you subscribe to
- Choice of warrant
You may wish to concentrate on the more actively traded warrants, as it will be easier to enter and exit positions in these warrants.
- Bid/ask spreads
When looking at the prices quoted in the financial press or on the internet, be sure to use the correct side of the spread.
If you are buying a warrant, the offer/ask price should be used; if you are selling a warrant, the bid price should be used. When valuing the warrant during its life, you should use the bid price, as this is the price you would receive in order to exit your position.
Brokerage will be charged when trades are transacted in the real market, so should be included when calculating the cost of entering or exiting a position.
Paper trading success is no guarantee of success in the real market. It is generally the case that profits are far easier to come by in a simulated environment than in reality. Emotions will be harder to ignore when real money is at stake.
However, if the paper trading process is used effectively, you may increase your chances of success once the real market is entered.