From our friends at PowerZone Trading...
Forward performance testing, commonly referred to as paper trading, is an important step in evaluating a trading system. Once we have determined that the performance metrics look reasonable in our backtesting with both in- and out-of-sample data, we are ready for forward performance testing.
Forward performance testing is the simulation of actual trading. Trades are taken on paper only, so any profit or loss is hypothetical. The trading plan should be followed exactly, including how the orders are placed. Many trading platforms, such as NinjaTrader and TradeStation, allow users to trade simulated accounts. Traders are able to watch live market data and place realistic trades, without risking any money.
One of the biggest challenges here is simulating a real trading atmosphere. Obviously it is much easier to play than to commit: trading for pretend and trading for real are two different animals. But we want to try to create the same types of pressure we feel when trading with real money. Here are some ways to keep your paper trading realistic: