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I have two questions here:

  1. When one first starts trading, what are some things that one encounters that paper-trading does not prepare one for?

    • The most common response I see for this question is, generally speaking, psychology. Novice traders become very nervous about having their money out there in the wild, so to speak, and as a result they frequently withdraw from positions at inappropriate times. Or worse, they avoid a trade altogether simply to avoid the nervousness, even if fundamentals and technicals suggest it is a good trade to make. I personally am not too worried about this, as I am an algorithmic trader, but that leads me to a related second question.
  2. In the real markets, are traders (on average) able to profit using strategies similar to the ones they developed paper-trading?

    • I have never seen this question addressed directly, ideally I would like to see a study done on it.
    • I frequently hear that strategies will perform very poorly in the real world if they were designed without taking into account slippage and commissions (I have never encountered a demo platform or backtesting engine that doesn't have these features, so I'm not really sure why anyone even bothers to warn about that). My biggest concern is, as mentioned above, the market psychology is drastically different on a demo platform, so is it even an accurate simulation?
  • Paper trading, it's just numbers. Real trading, it's real currency. The trading screen tries to remove thinking of real currency, but emotions, news, fear set in, and the real account suffers. – Optionparty Jan 8 '14 at 18:43
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The main thing that paper trading doesn't prepare you for is your emotions. Your emotions are what makes you second guess your trading plan, move your orders around when you shouldn't, get over greedy when things are going good and over fearful when not so good.

You also have to be prepared to miss out on certain trades or take slightly larger losses/smaller profits when the market gaps your order or your stop loss. This of course never happens when you are paper trading.

Your real trading will never be exactly the same as your paper trading due to having to deal with the fluctuating prices of a real market. However, if your plan/strategy worked with paper trading and you keep your emotions at bay as much as possible, you should also get good results in your real trading.

What you do need to be aware of is that the markets do change, so try to use robust strategies that tend to work over a wide range of market conditions instead of a strategy that is well configured to one market condition only (ie; when the market is in a strong uptrend only). Your paper trading should cover as long a period as possible to test as many market conditions as possible. This should ensure your real trading performs well too.

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