Paper Trading Commodities - Good or Bad?
The Good: Paper Trading is an excellent way to learn the mechanics of the commodity and futures markets. You should get a good feel for how different commodities trade as well as calculating the profits and losses. This knowledge is very important for when you start trading real money. Paper Trading is also a helpful tool for when traders fall into a slump and they need re-organize their trading plan and work on new strategies.
The Bad: Many would-be commodity traders achieve hypothetical profits when they paper trade commodity futures. The reason for this is that they typically take a longer-term view and look for good opportunities. They usually give themselves liberal fills when they place trades, don't add commissions and sometimes throw out bad trades that they "really" wouldn't have placed. But the most important difference is that there are no emotions involved in paper trading commodities. It doesn't sound like a big deal to someone who has never traded commodities before, but it is a HUGE issue to those who have - especially the unsuccessful ones.
Overall, I feel it is certainly helpful to Paper Trade before you put your money at risk, but it is not necessary. There is no way you are going to learn everything you need to know about commodity trading by simply paper trading. You have to put your money at risk and be in the trenches - that's how you learn about trading commodities. It's a whole different ball game when you have actual money at risk.
Key Points for Paper Trading Commodities
Learn the mechanics of the markets you want to trade. This consists of learning the dollar value per point, average daily moves of markets, trading hours, etc.
Find a timeframe you feel comfortable with. In other words, figure out whether you want to be a long- term trader, short-term or day trade commodities.
Decide what size account you will start with when you commit actual money. This will help you determine how much money you should risk per trade. You can apply this methodology to your Paper Trading and learn to live by this discipline. For example, you probably don't want to open a $5,000 commodity account and risk $2,500 per trade. One losing trade and your account is in serious trouble. Professional who run Managed Futures Funds and Accounts will typically have less than 2% of the accounts funds at risk on any particular trade. Obviously, that is not realistic on a $5,000 account. You have to accept more volatility in the value of your account when you start small. The point here is that you should choose trades according to a good plan and have an acceptable level of risk per trade.
Trading Real Money in Commodities and Futures will be more difficult than paper trading. Don't get too excited if you start paper trading commodities and have a couple successful trades from the beginning. This happens all too often. A new trader will get over confident and take on too much risk per trade and get wiped-out. Just be happy you're progressing and learning how to trade commodities and stick to your plan.
It's OK to be bored when trading commodities. You may not find a good trade setup for weeks. Give yourself a pat on the back for being disciplined and not chasing trades. However, if you do find your trade setup, you can't be afraid to pull the trigger.
Consider the costs of commissions and fees when you paper trade commodities. Commissions can add up very quickly, especially if you are trading commodities short-term or day trading.
If you are a longer-term trader you don't need to be glued to the screen all day watching futures quotes. This will drive you nuts and consume a lot of your time. It will also give you the tendency to mess with your commodity trades, which is almost always a bad idea.
It is not extremely difficult to make money trading commodities if you stick to a good plan. The problem most commodity traders have is that they cannot stick to a plan. They will have a bad trade or two and decide they need to do something different. In reality everyone has bad trades and a string of losing trades. That's just how things work. The successful commodity traders are the ones who have the confidence in their plan and stick with it through the rough times.
By Chuck Kowalski
About the Author:
Chuck Kowalski has been involved in the commodity and futures markets as a Commodity Analyst, Broker and Trader for more than 12 years. He holds degrees in Finance and Economics and is currently the editor of FuturesBuzz.com.