Paper trading is a practice that enables an investor or trader to try out buying or selling securities without risking their own capital by replicating actual market conditions and strategies. It helps them learn and hone their strategy before moving on to trading live. In the world of investing, that could mean looking at historic price and movement charts of a commodity or index on which to trade. In the world of foreign exchange, it might be a projection of the near-term rate movement. Today, this can only be done virtually, and is where many Wall Street pros cut their teeth. A paper trading account typically simulates real market parameters onto which aspiring traders can test their strategy. Paper trading is actually a vestige of the pre-digital era when trades were physically bought and sold by brokers in the trading pits. Back then, trades were also recorded on sheets of paper of the same name.
By using paper money, you can practise the skill of trading without exposing yourself to true risk, as you are trading not with real money but simulated money that merely emulates a real trading environment giving the opportunity to experience what it feels to trade in the real markets and enabling you to gain insights into how your strategy will fare in real market conditions before you commit real money.
For novices, paper trading allows them to begin their education in a safe Learning Zone, giving them a feel for the fundamentals of what it means to execute an order, manage a portfolio, determine risk tolerance and so on. More seasoned traders might use it to try out new ideas or refine existing approaches in a risk-free environment. Regardless of the trader’s experience, the most important part of paper trading is the ability to look back at your previous trades and assess your results.
Furthermore, most paper trading sites simulate live markets so closely that participants’ virtual holdings see realistic fluctuations in price and volume. And that realism translates in a way that’s apparently vital: prepping traders for the emotional realities of investing, such as volatility, without consequences.
In other words, paper trading represents a pragmatic approach to learning how to play the markets through apprenticeship in ‘real time’. It fills in that gap between book learning and practical experience, which is why it’s a vital rite of passage for anyone serious about the financial markets.
Paper trading, also known as virtual trading or sim trading, is a means for investing beginners and experts alike to test the waters in trading stocks or other financial instruments without risking any actual money. At the heart of the process is the simulation of a real market setting – you’d be able to engage in purchasing and selling securities based on real-time market conditions and data, but without the element of risk.
To engage in paper trading, you typically pick a platform that has this capability; many online brokers offer it. Once you set up an account, you receive a specific amount of play money – your ‘starting capital’, as it’s known in the parlance – and you have at it. The prices and movements of stocks, options, futures and other securities or financial instruments mimic what happens in the real world, meaning you can see how your trading strategies would hold up under actual market conditions.
But it starts with doing some research on possible investments once you learn how, you determine in your portfolio whether to buy or sell these, then your transactions are recorded within the ‘paper’ platform. Appropriately, detailed reports and analytics of the progress within the past periods are provided by the service, allowing you to have an overview of where you’re succeeding, and where you’re failing, theoretically, without any real financial loss.
Not only that but paper trading helps you get comfortable with your investing skills and boosts your confidence, which is greatly beneficial to any investment strategy. By watching over time how the strategies you’ve incorporated work out, or don’t – or by observing how your risk preferences change – you can collaborate with your virtual self and get better over time. Capitalising on the dissonance between loss aversion and overconfidence, paper trading allows for new strategies to be backtested in a money-free environment, which leads to a more realistic implementation of those strategies when real-money is involved. Equally important is learning how to use synthetic instruments such as derivatives. Although paper trading has its benefits, it is also possible to oversimplify real-world investing if not done properly.
Paper trading is when traders pretend to trade in the market by opening all the actual trades which a live trader opens but without real money – the actual cash gets deposited once the trader is comfortable and active enough. It has multiple benefits for novice as well as experienced traders. One of the biggest benefits is that it’s risk-free – it doesn’t mean that paper trading is risk-free, it means that even if you lose a lot of money, you still won’t lose a lot of money – you’ll just lose money on paper, thus, paper trading. For a beginner, this can be used to learn the ins and outs of how market operates, he /she doesn’t fear loss (because there isn’t one!) and can therefore test different trading strategies, learn market movements and get used to trading terminal.
For an experienced trader, paper trading is an invaluable tool for testing new strategies or adapting existing ones to a changing market. Even the most experienced trader has no idea how markets will act on any given day. They might have made a lot of money on Friday but market behaviour can change on a dime, so through paper trading an experienced trader can alter the method to fit the market.
A second big benefit has to do with emotional preparedness. As we all know, trading can be psychologically and emotionally gruelling. Fear and greed can both lead to illogical conflicts of interest that result in losses. Paper trading can play a part in helping a trader to avoid these extremes of psyche by exposing him or her to simulated real-world market movements in a safe setting, thereby conditioning the trader emotionally before placing real money on the line.
Second, it can also help your technical skills, by giving you experience with the various technical tools and features that trading platforms have. Having experience and knowing how to use various technical indicators, charting features and such can make a big difference when you actually start trading in the real market.
Finally, paper trading is a form of education, one that allows newbies and veterans alike to try out and gradually improve their ability to cope with fear others; to grow their emotional stamina to last them through the down market; to develop and test strategies. In the long run, these qualities are the essential distinguishing factors between the winners and the losers.
Now, don’t get me wrong – paper trading can offer a low-threat learning and practising environment. But it comes with several caveats. Most crucially, it simply doesn’t replicate the quality of the ‘real’ experience. One key way in which it lacks reality is that it’s an emotional wasteland. When you’re not risking real money, you don’t get the sense of threat and emotional arousal that go with it – the sweaty palms, fast heartbeats and the racing thoughts that studying alone can’t replicate. Without the emotional pressure of putting your hard-earned money on the line, how can you know what trading would actually feel like? What happens when you move to live trading? The emotional pressures mount, but without any of the amount of practise you require to properly learn will be absent, too. This can make it harder than you might expect.
Even so, an absentee lifestyle – the paleolithic instincts and emotions of fear and greed – make a significant contribution to the decision-making around following a strategy or not, and also over risk management. Another limitation of paper trading is around conditions of the market itself. Most paper-trading platforms will not replicate the nuances of real markets such as slippage, which happens when market volatility means your order gets executed at a different price to the one you asked for, and liquidity issues that impact the ability of an order to be executed at all.
These factors are important to the real dynamics of market activity but are often glossed over or removed entirely from a paper trading environment. And another key difference with actual markets is that paper trading is usually supposed to unfold instantaneously. In the real world, trades could be delayed because of network latencies or because of inefficiencies of your broker in your geographic location – delays that, depending on the market activity, could have a huge impact on the final outcome of your trades. And sometimes paper trades might even eliminate certain fees or commissions that you would incur in the real world, which means they would be cheaper than they would be in reality, and that would be a mistake for the trader to make.
Finally, there’s a psychological aspect of commitment and discipline. Since paper trading isn’t linked to any serious financial consequences, perhaps those engaging in it develop bad habits or stack the deck too much in their favour – and end up with poor practice for real-world market conditions where disciplined execution of a strategy truly matters.
As noted earlier, having the right tools for paper trading can themselves help build the skills you need. For example, the most effective of these environments simulate real market conditions so that you can test your strategies without putting actual money at risk. Second-generation paper trading sites offer ‘real-time’ data feeds showing current prices and trends.
Many full-service brokerage houses come equipped with a paper trading account buried inside their trading platforms. For example, TD Ameritrade’s paperMoney feature is included in its thinkorswim platform, where you can toggle back and forth between the two worlds.
On top of the various brokerage-based trading simulators described in the previous section, there are also standalone apps dedicated entirely to paper trading. Many of these apps tend to go beyond what brokerage-based simulators offer by incorporating more advanced charting software with a variety of technical indicators as well as social features where traders can share ideas and insights with each other. Examples include TradingView’s Paper Trading feature or NinjaTrader’s simulation capability.
Furthermore, thanks to mobile apps, you can practice trading on the go as well. These intuitive and robust applications offer you the flexibility to hone your proficiency from anywhere at any time.
At the end of the day, it’s going to be what works best for you but fortunately, most of today’s platforms offer a comprehensive set of tools, from the beginner looking for simplicty to the professional who demands sophisticated analytical tools. By using any of these correctly, the budding trader can gain confidence and develop competence before entering the live markets.
A paper trade is fine as a vehicle for practice until a trader is ready to make the switch to live trading. When that time comes, that’s another story. Starting out live trading would be like driving a car without ever having put pedal to metal.
Ease of transition is one key consideration When you are paper-trading (ie, simulating), the trades you take are not real – you are not risking any real money. Thus, the emotional feelings of great highs for winning trades, and great despair for messy trades, are not available to you in the sim. Fear and greed are killer emotions, and the sim will never match them. Moving to the live market will feel very different; this dissonance can change the way you perceive things. It pays to start off small with live trading, and enter positions that grow your confidence along with keeping potential losses in check.
Another crucial part of the puzzle is getting to grips with slippage and execution issues. In paper trading you execute a trade using hypothetical prices that ignore the effect of order flow and market depth; however, live markets involve real executions which may suffer from price slippage depending on factors such as liquidity, order volume and speed of execution, which can affect the execution price as distinct from the announced price. Traders need to be prepared for this and gear their strategies accordingly.
Moreover, a move into trading with real money requires much greater discipline and thought about risk. For instance, the theoretical models or virtual simulations might prescribe certain parameters of risk-taking, but in the real world such nuances unfold during practice and implementing the models necessitates much stricter discipline in choosing stop-loss orders and sizes of positions.
Finally, we must have realistic expectations. Real-time or live trading during the first stage is unlikely to yield a positive return, and needs to be seen as part of a continuous educational process, with ongoing improvement the goal. As long as this transition is handled in a systematic and mindful manner, with paper-trading lessons gradually implemented in real time, traders will maximise the odds of lasting success in the markets.