Why Use a Trading Simulator?
Using a trading simulator is a powerful way to improve your trading skill, develop your strategies, and avoid the many pitfalls that lead to significant losses.
Many traders dismiss simulators and think they're not as important as learning in the live markets. They argue that the psychological aspect, a crucial part of trading, cannot be genuinely simulated. However, there’s more to trading than just the psychological aspect.
Like any complex skill, trading requires structured progression that can be broken into four stages:
1. Knowledge acquisition
The initial stage relies on learning the knowledge of trading through reading, courses or online videos. A simulator could be used to put certain things you learn into practice.
2. Skill drilling
The second stage focuses on repeating a specific skill or technique over and over again, be it breaking down the market structure, practicing significant levels, or identifying price action. A simulator allows you to practise these skills more often than live markets would allow.
3. Simulated performance
Next comes simulated performance - self-explanatory, right? This is when you practice your trading in many different market scenarios and build confidence through consistent performance over a substantial sample size. This will ensure you're prepared for the live markets.
4. Real-time performance
Finally, there's the stage of live performance. Consistent, profitable performance in a simulator over a large sample size is your green light for live trading. The simulator allows you to collect all this data much quicker than in the real markets.
These stages apply even to other skills with a strong psychological component. Why should trading be any different?
In fact, learning to trade in the live markets is often the cause of many persistent trading psychology issues.
Neuroscientists have found that our brains perceive financial threats similarly to physical ones. As a result, beginner traders may experience a form of trauma when their emotional processing becomes overwhelmed by losses or unexpected gains. These experiences often lead to conditioned responses, causing traders to react unconsciously and automatically to specific triggers.
These issues may not appear significant in the initial learning phase but can later sabotage your trading performance, they include things such as:
- Moving your stop loss unnecessarily
- Closing profitable trades prematurely
- Engaging in revenge trading
These psychological obstacles often originate in the live markets. A trading simulator offers a safe space to develop your skills and gather implicit knowledge without the risk of developing trauma-induced conditioned responses. More seasoned traders can also use simulators to collect data and try various market situations without the need to trade in real-time.
To draw a parallel, this is similar to a military training exercise. There's nothing more psychologically impactful than fighting in a war, and this can't be replicated through simulation. Despite this, soldiers obviously still go through training, so why is that? It's because training prepares them for different real-life scenarios. It offers a chance to learn foundational skills, create and test strategies, develop the ability to adapt, and have more effective decision-making.
But a trading simulator isn't just for learning to trade. It can also be for enhancing your performance, even once you're consistently profitable.
Simulators make it much easier to collect lots of data, ensuring traders aren't misled by small, variable sample sizes. It negates the common fallacy where traders mistake temporary profitable results as evidence of a profitable system. Most importantly, a trading simulator is a tool that is available 24/7, 365 days a year, allowing you to refine your skills in whatever time you have available.
Reflecting on my own journey, had I had the opportunity to use a trading simulator, I could have bypassed years of trial and error, including significant financial loss.
How to Get Started with a Simulator
The first thing you’ll need to do is download your simulator. I would personally recommend using Forex Tester, and if you use the code DUOM10 you can get an additional 10% discount.
Once you've successfully installed the trading simulator, the next step is to download some data. The specific data you download will be depend on the markets you trade and your trading methodology.
For instance, you don't need to download all the tick data if you prefer to trade higher timeframes. Some simulators will give you different options, such as using 1-minute data. Using the 1-minute data instead of tick data will save drive space and download time - the files can end up being quite large otherwise!
If your trading involves lower intra-day timeframes, such as the 5-minute, or 15-minute, it could be worthwhile to download the tick data. However, to prevent the download from taking too long and using too much space, it's best to just download one or two markets at a time over a shorter period of time.
I'd also recommend downloading news data. This will allow you to see upcoming news events and prepare for them.
Understanding the Features and Functions
Our ultimate goal with the skill aspects of trading should be to reach a level of unconscious competence. This is where our trading actions become intuitive and we don't have to think through every step.
A common misconception is that expert traders must have their minds continuously whirring, engaging in constant mental activity. However, scientific studies from neuroscience suggest otherwise.
Our brains go through much more activity when we're new to a task, but as we gain expertise, the neuronal activity decreases. This reduction happens because many actions become automatic, much like habit formation. The brain is a metabolic powerhouse, so it's good at conserving energy. Automating frequent actions offers a dual advantage – saving energy and freeing up cognitive resources, enabling traders to focus more on the unique aspects of the situation they're facing and making the right decision, rather than on skill execution.
With this in mind, an underappreciated factor is how familiar you are with your trading platform. If you're constantly changing your platform or using new features you'll be increasing your mental load, which will diminish your trading performance.
Therefore, the very first step when using a trading simulator should be to thoroughly familiarise yourself with all the necessary functions. Perhaps even set up shortcuts or customisations that make things more efficient.
Here are some key aspects you should consider becoming familiar with before you begin trading with it:
- Creating a new project
- Saving a project
- Creating a personalised chart template
- Drawing and altering levels, modifying their colours and properties
- Incorporating indicators
- Starting the simulator, pausing it
- Modifying the speed
- Navigating to a specific time period
- Adjusting timeframes and integrating more charts
- Understanding the variety of orders
- Opening trades and setting stop losses
- Modifying a trade position (scaling in / out)
- Closing a trade
- Taking screenshots
- Looking at the account history (P/L, return)
- Exporting the account history
You can watch me go through each of these features in the video version of this guide.
The Benefits of a Trading Simulator
I mentioned a few of these benefits earlier, but now it's time to elaborate on them further.
Flexibility With Time
One significant advantage of a trading simulator is the ability to change the pace - you can accelerate it, slow it down, or even rewind it to replay specific moments. This flexibility is beneficial for purposeful and deliberate practice sessions (which we'll discuss more later). In live markets, we're stuck with a single speed.
Research on deliberate practice suggests that creative methods are often required to break through plateaus in your progress. This creativity could result from changing the speed of the skill being practised. Sometimes, you might need to slow things down to better understand the individual steps, or occasionally you may need to speed things up to add more pressure and urgency to your actions.
Running your simulator at a pace quicker than real time reduces the time you have for decision-making. This pressure mimics the fast-paced decision-making process in live markets, where emotions are heightened, and time seems to be flying. You might struggle to decide whether to enter or exit a trade and identify threats or opportunities – the simulator can help prepare for this by reducing your decision-making time.
Although it doesn't replicate the urgency felt in live markets, it simulates it in a different way. This exercise allows you to begin adapting to more intense situations without risking real money or creating counterproductive conditioned responses.
Another benefit of fast-forwarding time is the ability to swiftly progress to the next trading opportunity. One of the challenges of learning in live markets is the considerable amount of time spent waiting for opportunities. The thrill of learning often pushes individuals to take rash actions simply to avoid boredom and keep the excitement going.
Furthermore, skill development involves repetition, similar to building your muscles at the gym, where lifting heavier weights repetitively results in growth. In trading, skills are refined through frequent repetitions, and the fast-forward function allows for more repetitions in less time.
There are also times when you need to break down a skill and provide yourself with more thinking time. The simulator allows you to slow down time to carefully consider all aspects of a situation. Gradually, you can increase the speed to adapt to processing more information at a faster pace.
In the live markets, adaptation to a faster pace often results in cutting corners, processing less information, or resorting to higher time frames that may not suit your trading style. The simulator offers a more practical alternative.
A simulator also allows more rapid development and more repetitions by allowing trading practice on weekends. If you work weekdays, weekends might be the prime time for learning.
Real-Time Price Movements
Moreover, the simulator isn't static – it operates like a live trading account. You can open and close trades, build up an account, and monitor price movements in real time, not just viewing completed candlestick charts. Importantly, this means you're gathering data that can be analysed to fine-tune your approach, test new strategies, or identify weaknesses.
One issue many new traders face is they switch too quickly to a live account with real money, often based on an insufficient sample size showing their supposed consistency. A simulator allows you to collect data to support your live market trading, providing greater clarity about your actual stage of development.
Experiencing Different Market Activity
Lastly, a crucial aspect of becoming a great trader is exposure to a wide range of market activity. Typically, traders gain this experience over several years by trading through various market events and cycles. However, with a simulator, you can compile a list of all the events you wish to experience and trade them retrospectively. Fancy experiencing the 2007-2008 financial crisis? No problem, just set your simulator to those years and start trading.
As you can see, using a simulator instead of live or demo accounts allows you to cram a significant amount of learning and experience into a relatively short period.
The Drawbacks of a Trading Simulator
Psychological Aspects of Risk
While the mechanics between a simulator and a real-time market are virtually identical, a simulator can't fully capture the psychological elements involved in trading. We can attempt to inject a degree of risk and stress into the simulation, but the impact of having real money on the line and how we manage that risk, can't be fully replicated. So, how can we overcome this?
As I previously mentioned, the optimal learning path consists of four stages:
- Knowledge acquisition
- Skill drilling
- Simulated performance
- Real-time performance
Stage 4 is the live performance. Consistent, profitable performance in a simulator over a large sample size is your green light for live trading. However, the key challenge lies in how the risk of real money will impact your decision-making process.
A phased approach can help manage this transition, where you start with a smaller account balance. As you grow more comfortable, incrementally increase the risk. For example:
- Month 1: Trade with 20% of your capital
- Month 2: Trade with 40% of your capital
- Month 3: Trade with 60% of your capital
- Month 4: Trade with 80% of your capital
- Month 5: Trade with full account
Note: these percentages refer to the balance in your account, not to the percentage at risk for each trade.
This process, known as graded exposure, helps you adapt to increasing risk levels without disrupting your decision-making processes.
Another drawback of using a simulator is the potential for developing detrimental habits. Because simulators allow us to fast-forward, traders can become accustomed to constant action, neglecting the need for patience.
Boredom could lead to impulsive and inappropriate actions when you trade in the live markets. Over-scrutinising every market move could lead to unnecessary actions, such as:
- Prematurely closing trades
- Scaling in or out
- Adjusting your stop loss
- Revenge trading
The remedy to this is straightforward. Prepare yourself for the live market phase by gradually reducing the simulator pace over several weeks or by restricting the use of the fast-forward function. This will help you develop the patience and the discipline to wait for the right opportunity. It may seem time-consuming, but it prevents trading losses and saves real money in the long run.
Furthermore, the data collection process using a simulator can also lead to rushed analysis, leading to rushed trades. Trade journals often highlight this; traders usually provide detailed trade descriptions that offer more learning and optimisation opportunities when trading a demo or live account. However, many don't give simulator trades the same commitment.
Another downside is that simulator use may result in an over-reliance on explicit learning while minimising the opportunity for implicit learning that live markets offer, which is critical for successful trading. This can be overcome by following a simulator at a real-time pace as the price approaches critical moments (e.g. interaction with a significant level), or making time each week to also follow the live markets.
Lastly, the cost can be a drawback. I have yet to come across any free simulators, especially good ones, and the price might seem prohibitive for some. However, considering it as an investment in your development as a trader, the cost is justified. It may even save you money in the long run by preventing live market losses.
Although the downsides of a simulator imply that live market learning is necessary, this doesn't mean the simulator isn't needed. Using them alongside live trading, whether on a demo or live account, can accelerate your learning process. You should divide your week between simulator time and live market time to make use of the strengths of both.
Here’s a visual guide to help you transition between phases and prepare for the next one. It can be used as a roadmap for your trading development plan.
Even if the four-phase approach doesn't appeal to you, a hybrid approach can still be beneficial. Trade the live markets during the week and utilise the simulator over the weekend to fill in gaps unmet by the live markets. This method provides a compounding effect on your skill development.
How to Use a Simulator for Improving Our Trading
There are three categories of practice that you can undertake:
- Ordinary practice
- Purposeful Practice
- Deliberate practice.
Ordinary practice is the default for most traders. This is merely following the charts and trading.
You can develop to a certain point with ordinary practice, but then your progress will plateau. You are no longer pushing yourself beyond your comfort zone.
To explain this, I like to compare it to learning to drive. Initially, during driving lessons, you go through rapid development because the focus is on specific skills. However, once you pass your test, despite gaining more road experience, your skill level remains stagnant even after many years. This is because your everyday driving falls within ordinary practice, staying within your comfort zone.
Purposeful practice is more refined and focused. You break down the overall skill into its component parts (or 'chunks') and set specific goals for each practice session. It's about determining a particular aspect to concentrate on and understanding what you aim to achieve.
Your goal should be to consistently push yourself within the skill-challenge zone. Not within your comfort zone like ordinary practice, and not too challenging that you can't achieve the aim for the session and end up getting disheartened and frustrated.
The next level is deliberate practice. This often requires a coach or mentor who has already achieved your desired success level and knows the route to it. They provide instant feedback and suggest ways to modify your practice sessions to overcome challenges.
Planning Your Practice Sessions
Here are a few key elements to consider when designing your practice session:
- Deconstruct a skill into its primary components
- Focusing practice sessions on a specific target from these components
- Pushing beyond your comfort zone
- Getting feedback
- Going through repetitions
To deconstruct skills into primary components, you would need to have acquired knowledge or had a mentor do it for you. For deliberate practice, an expert's feedback is crucial. However, all the other elements are manageable within a simulator, which would otherwise be difficult without it.
You can also establish unrealistic restrictions and parameters that force you to trade under more challenging circumstances. This could include creating scenarios, similar to rehearsing set plays and situations when training in a sports team.
Here are some scenarios you might want to consider, but the possibilities are endless. It is also helpful to take note of any difficult situations you encounter in your real trading, find similar situations and practice until you're comfortable with them.
- Starting in a drawdown with limited time to get back into profit.
- You are managing a profitable trade at a random point in time and have to decide the best time to exit (measure success against the profit potential before or after your exit point).
- Flip a coin to choose market direction - enter a trade with x lots and move ahead 10 bars. Find the best time to exit.
- You have to achieve a return of 6% on a trade while only having a maximum 0.7% at risk at any time (using scaling in and moving stop loss to cap risk).
- Limited time to achieve a return of x% without exceeding x% drawdown.
- You can only trade based on ranges.
- You can only trade based on structured trending moves.
- You can only enter trades based on your weaknesses (find this from your data).
- Trade a month in double the speed of real-time on your usual time frame (preparing for high pressure).
- Trade during a high volatility period.
Creating and Drilling Your Trading System and Strategies
Testing the System
A trading simulator is an excellent tool for testing your system. It helps identify weaknesses, strengths, or elements that may require modification.
Firstly, it provides unlimited fresh charts, allowing you to run your system through new situations by moving backwards or forwards in time. Whereas, live markets only offer a limited number of fresh charts before they've been analysed and become temporarily redundant.
Secondly, the simulator allows you to test your system quickly across diverse market contexts. This quick assessment can highlight potential steps that may need to be added for specific market types, preventing wasted time running the system in live markets only to encounter unforeseen obstacles.
The simulator is also the perfect tool to drill and repeat the system, so you can run through it seamlessly.
Traders often blame a lack of discipline for failing to follow their system. In most cases, the real issue is that they lack unconscious competence with their system, causing them to revert to instinctive, conditioned responses under pressure. Just like mastering any skill, proficiency in using your system requires repetitio.
Testing the Strategies
The success of any trading strategy should be determined based on whether it delivers a positive expectancy. A big part of estimating the expectancy of an opportunity or strategy (and the one most traders miss) is the probabilities of the potential outcomes.
A great way to improve probability estimation is to test and collect data. This process can be lengthy, but it's worthwhile. Trading simulators significantly reduce the time required compared to live market testing.
There are two common errors traders make during this process:
1. They operate with insufficient sample sizes, resulting in inconclusive statistics due to high variability. A trading simulator can help you rectify this issue by allowing you to gather large sample sizes quickly. For instance, a weekend spent testing on a simulator can achieve the same results that would take weeks, months or even years in the live markets.
2. The second mistake is the need for more diversification within the sample size. Traders often compile large amounts of data but fail to differentiate between different trading situations, each with their own probabilities and influences on success rates. Therefore, despite a large sample size, the data may remain skewed and unrepresentative.
A trading simulator help avoid this issue by allowing you to test various market situations individually, keeping track of the performance of each. The results can then be exported to spreadsheets to further break down the data and identify areas for improvement.
Beyond the initial system creation, this method can be utilised throughout your trading career for continuous optimisation. It enables quicker data collection, providing sufficient sample sizes for meaningful analysis. It's also a fantastic tool to test new approaches, a topic we'll delve into next.
Our Trader Development Program outlines tried-and-tested approaches for all these steps, offering detailed insights to enhance your trading capabilities. Here’s a list you can follow to track your system and strategies:
- Track each trade in your qualitative journal
- Copy the data from the simulator into the quantitative journal (your spreadsheet)
- Repeat the first two steps to collect a large sample size
- Review the trades in your spreadsheet and/or journal to raise questions
- Use the qualitative journal to discover what’s happening in those situations
- Use your discoveries to answer your questions and potentially change your approach
- Test the new approach on a simulator to see how performance changes
- Collect more data to answer questions not answerable in your data
Explore Different Trading Styles and Approaches
Optimal trading performance comes when you discover a trading style that genuinely suits your individual requirements, not by copying someone else. The most effective way to identify this is by experimenting with various trading styles until you find one that feels like a good fit.
Even if you choose to stick with your initial trading style, experimenting with other styles equips you with additional tools in your trading arsenal. This variety of knowledge, although not always useful, can improve your trading tactics in ways you might not anticipate.
However, this commitment might be less productive in live markets. Let's assume you spend three months on each style. What if a particular approach only generates one trade per week? That equates to roughly 12 trades over the three-month period. Or what if the strategy is long-term, resulting in only one or two trades?
Instead, you can use a trading simulator and put together a detailed plan for different style rotations over a specific timeframe. You could dedicate two months to each style, creating a year-long schedule to explore six varied styles. Using a simulator instead of live markets, means you can condense years' worth of trading into these two-month intervals.
As mentioned earlier, even if you don't discover a superior approach to the one you initially planned to use, this method of exploration is a powerful way to acquire additional experience and add to your trading skills.
Practicing Historical Scenarios
Finally, let's talk about practising historical trading scenarios. Have you ever wished you could see what it was like to trade during big events like the 2008 financial crash or the Covid-19 pandemic? A trading simulator lets you do exactly that. It's a fun way to try something new and test your trading strategies.
Remember Covid-19? Market conditions were notoriously unpredictable, and this went on for months. We could have waited for markets to return to normal conditions, but that would result in barely any trading for an extended period of time. If we traded normally, that could have resulted in losing money unnecessarily. The alternative is to adapt our strategies to suit different market conditions.
Let's also look at another big event - Brexit. Brexit was a referendum in the UK about whether to stay or leave the European Union. The result was a surprise to most people and the markets. You can see the market's reaction on the simulator by going to the date of the vote - June 23 2016.
The simulator allows you to practice during these types of scenarios and find out how well your strategies hold up, and perhaps figure out ways you could adapt to it without needing to wait for normal market conditions again, which could take some time.
These simulated challenges allow you to adapt under high-pressure conditions, leading to implicit and explicit learning. The more you practice, the better you'll handle them. You'll learn a lot, and you'll be more ready if something similar happens in the future. This preparedness minimises the element of surprise and reduces the likelihood of panic or confusion.
Here is a list of some significant events you can run through on a simulator to get familiar with market reactions to different assets:
- The 2008 Financial Crisis - September 29, 2008
- COVID-19 - 19 February 2020
- Russian Invasion of Ukraine - February 24 2022
- Flash crash of GBP - October 6 2016
- Flash crash of CHF - January 15 2015
- Flash crash of JPY - January 2 2019
- Surprise Brexit Vote - June 23 2016
- 9/11 Terrorist Attacks - September 11 2001
- UK Budget Crisis - September 26 2022
- US Federal Reserve Continuous Hikes - 2022 - 2023
As we covered earlier, there are different scenarios we could use for each of them. So here are some examples of some of those too:
- Find which markets were most affected and try to find precise entries
- Manage a trade during a sudden change in volatility
- Discover how your system and/or strategies perform in volatile situations
- Test different strategies to adapt to changing market conditions
- Wait for when the volatility declines to find entries
- Look for potential markers in the fundamentals and find entry points that align
On the other hand, you might want to experience different market types rather than specific events. So here is a list of market types you could go through and the dates to put into your simulator:
- AUD/USD (Daily) - 29 January 2018
- GBP/USD (1 Hour) - 19 November 2021
- AUD/USD (5 Minute) - 18 October 2019
- USD/CAD (1 Hour) - 4 February 2022
- EUR/USD (1 Hour) - 11 March 2019
- USD/CAD (1 Hour) - 10 January 2023
- EUR/USD - 15 December 2021
- EUR/USD - 30 June 2014