Sunday, February 14, 2010

Training Traders: The Role of Simulation in Supercharging Learning

A recent research report suggests that computer simulations can be as effective as direct observation in education. Simulations have long been used in medical education to help students learn the skills of physicians. Simulations are also standard in training airline pilots and in preparing for war scenarios. By trying out moves against a computer, developing chess players can work on various aspects of their game.

When I directed a training program for new traders at a prop firm, we found that simulated trading using live market data was especially helpful in preparing traders for shifting market conditions, dealing with uncertainty and risk, and making rapid decisions. Interestingly, we also found that when simulations were graded and reviewed by an instructor, they also incorporated some of the performance pressure faced during actual trading. If a trader knows that he has to sustain profitability in simulation mode before trading live, the simulation begins to simulate the emotional elements of trading.

Simulation, however, entails several advantages over live trading for training purposes:

1) Simulation allows traders to make mistakes and try out tactics without losing money early in their developmental processes;

2) Simulation allows for more focused learning, as traders can replay aspects of the day to rehearse trading under specific conditions;

3) Simulation provides standardization in learning, as trading days can be archived and traders can practice trading specific kinds of market conditions from the archives;

4) Simulation enables traders to get more learning into a day's period than would be possible during live trading, as many days' worth of experience can be concentrated into a single training day.

5) Simulation offers an objective test of traders' skills. If a trader cannot be successful in simulation mode with live market data, surely he will not succeed under the more strenuous conditions of having real money on the line.

A number of trading platforms and programs offer a "replay" mode that can serve as simulation-based learning for traders. By replaying challenging periods in the market, traders can observe mistakes that they made and correct them before the next day begins. That supercharges learning.

In my book Enhancing Trader Performance, I devote considerable space to the topic of simulation. My conclusion: "Research and experience suggest that the single most important investment you can make in your trading development is the acquisition of software that will allow you to develop your own training program and drill the skills that are central to your trading niche" (p. 100).

The great weakness of most "training" programs for traders is that they provide information, rather than develop skills. Information is necessary but not sufficient for the cultivation of expertise. Learning about chess or about surgery will not, in itself, create a chess champion or an elite surgeon. We can learn a great deal of information about football, but remain unable to master the game.

There is a very straightforward formula for success across performance fields: find the performance area that best matches your interests and talents; engage in structured practice under safe conditions to master the skills that are components of success; engage in realistic practice to assemble those components into actual simulated performances; and then tackle real-world performance situations with ongoing feedback and efforts at improvement.

Traders don't fail because they lack the right setups or because they weren't born with the right trading personality. Traders fail because they do not survive their learning curves: they put their capital at risk long before they have developed necessary skills and expertise. Simulation-based learning is a way to accelerate that curve and reduce the costs associated with the inevitable mistakes made by learners.



Steve Willette said...

I have mixed feelings about "simulation trading" or "demo trading" if they are one in the same.

It makes sense because I think trading is a performance activity, like a sport or a music recital. You would practice for both of these activities before the actual event.

One thing I learned from the person who taught me to trade was that if real money is not on the line, you are prone to take risk you wouldn't if you were trading with real money.

In my own personal trading, I am not where I want to be yet and have lost money on mistakes that I probably wouldn't have made if I demo traded. But I can see myself taking bigger risks if I demo traded before trading with real money.

One other thing I was taught, was to observe market activity in regards to your trading system and when you become comfortable with price action, then start trading. I guess that would be like simulation trading. Thank you for the post, Steve


Jorge said...


I would say that the use of simulation/demo in trading has three distinct stages:

1) Becoming familiar with the platform and the different types of orders. I'd say that most people have no objection to its usefulness.

2) Drilling, where in either live or replay mode you first drill different techniques and strategies with different holding times to see which you are more comfortable with or successful at; then you do some further work on improving and refining your performance in specific areas. From what I see, many people tend to skip this stage in favor of the last one and fail to go back to it when they make changes in their plans.

3) Paper trading, where you trade according to your previously developed trade plan, without risking your capital. This is what most people understand by demo/sim trading and while it's important and has value, it presents several problems for most people.

First, many people indeed tend to take risks they wouldn't when trading with real money - particularly if they only have a vague trading plan - usually out of boredom; second, because they're mixing "play" trades with trades called for by their plan, they lack a realistic assessment of their skill or degree of development ("Yes, I lost $300, but in real trading I wouldn't have made this and that trade, so I would have ended up with +$800"); third, this lack of realism and objectivity in their simulated trading leads them to avoid responsibility for and ownership of their results, leading them to trading in an environment, not of reduced stress (as in being accountable for your losses, even if they don't result in actual financial damage), but of no stress (plus over-stimulation and over-confidence).

Thus, mixing the play and high frequency trading of the second stage with the strict discipline and self-restraint of the third one, negates the benefits of both, which is why making a poor use of simulated trading is actually, in my view, counterproductive.

On the other hand, when properly used, I have found demo trading priceless, and even to this day (while trading live) I still use a demo account in parallel to the live one to warm-up in the morning and to have a reference of how related markets are trading during the session.

Best trading (demo or live) to all,