This is the third and last article looking at the importance of paper trading. In this article I present the steps I take to paper trade a new strategy to be profitable as well as protect my overall portfolio. I assume investors have read the other two article in this series:
1 – The Importance Of Paper Trading
2- Settings Goals In Paper Trading
Paper Trading can be beneficial to a portfolio as it protects the portfolio from losses when testing and refining a new strategy. But paper trading also can assist a portfolio by allowing an investor to test strategies for profit potentials. When goals are set, a new strategy is tested to see if it can meet some or all of those goals. This allows an investor to see how profitable a strategy is. Through paper trading new strategies and refining old ones an investor can rotate through various strategies, discarding strategies that are either poor performers or replacing them with similar strategies that are more profitable. This continues to increase the returns in the overall portfolio as well as strengthens it to protect against market downturns, mild or severe.
The 3 Keys To Investment Strategy Development
All of the strategies I use today in my portfolios, went through a period of paper trading. There have been many earlier strategies that have long since been replaced by other strategies that proved:
- More profitable
- Easier to manage
- Responded better to rescue strategies
Those have been the 3 most common reasons I have replaced older strategies with new ones. For example my SPY PUT hedge strategy was paper traded for about 3 months back in 1993 and replaced a completely different hedge strategy. The returns from the original hedge strategy prior to 1993 averaged about 15% a year during markets that were in periods of correction. My SPY PUT hedge has had many years when it has protected my entire portfolio by more than 30%. You can see then the importance of paper trading a strategy to determine its usefulness and profit potential.
How I Use Paper Trading
To paper trade a new strategy successfully an investor must make 
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