Paper trading – Everything you need to know

Paper trading can be a valuable tool to both novice traders and veteran traders alike. There are plenty of advantages to using paper trading but there are a few shortcomings as well. Let’s see how you can most effectively use paper trading to your advantage. 

What is paper trading?

In a nutshell, paper trading is essentially a way for traders to learn more about buying and selling stocks without actually using any real money. There is no way for traders to make any real money from paper trading but the experience and learning they gain from paper trading is invaluable to their future real-world trading endeavors. 

But if you aren’t using real money, how can you possibly learn how to effectively buy and sell stocks? Well, there are a couple of different approaches to paper trading that we will get into shortly but in essence, you are still looking at real world markets and charts and theorizing when you would open and close your positions. 

The idea of paper trading is not strictly reserved for novice traders but is in fact used by experienced traders as well, to practice new ideas or strategies they have been putting together. Let’s take a look at the actual practice of paper trading.

Basic approaches to paper trading

The first basic approach to paper trading is by simply using a pen and paper. This sounds a little rudimentary for something like buying and selling stocks but there is nothing wrong with jotting down your simulated trades on a piece of paper. 

You would find a chart online through any number of sites, write down the ticker and then decide when you would theoretically make your purchase. You write down the opening price and then keep an eye on the stock throughout the day, deciding when the ideal time would be to buy. Novice traders will then start to learn facets of trading like when to place their stop orders and how long they should hold their positions open. 

At the end of the day, the novice trader then writes down the exit price of the stock. After this process has been done enough time, the novice will gather enough data to see where they can improve and where they have done well. 

Using excel is another way to go about accurately recording your paper trading. Excel gives you access to a number of tools that can give you a more fully formed picture of trading sessions. For example, you can monitor things like volume, sectors, time placements, holding periods and more. 

Using a stock market simulator

Trade simulators are arguably the best approach for novice traders to take. These trade simulators are offered by online brokerage firms for free these days. Typically, you can find a site that will allow you to create a demo account which gives you access to all of the site’s trading software. 

This means that you can use all of the real trading software you would use in real world trading scenarios. This is invaluable to the novice trader as they can then seamlessly move from their demo account to a real trading account, having learnt how to use all the tools they need. 

Advantages of paper trading

The advantages of paper trading to a novice and even to a veteran trader are invaluable. It’s no surprise that professional traders and market personalities recommend that new traders take part in paper trading and here are a couple of reasons why. 

No capital risk: as we have already touched on, the main perk of paper trading is that you won’t be risking any of your brown capital. The whole point of the process is that you get a lay of the land without having to risk your own money doing so. 

Trade experience: without the risk of losing your own money, you can firmly concentrate on the experience of trading itself. The more you use paper trading, whether by jotting things down with a pen and paper or byu using a market simulator, you are gaining valuable experience while doing so. 

No stress: when you aren’t having to buy and sell using your own money, you are immediately removing the stress of the situation. Real world trading can be genuinely stressful so you can imagine what it would be like if you jumped straight into it without any experience or practice that paper trading would have provided you.

Building foundational data: the more you use paper trading, the more real world data you will accrue. You may be using fictional funds with a market simulator but the data that you are using is very much real. This will give you a great base to work off of in the future and will help you to potentially inform your choices to buy or sell in certain markets. 

General confidence: and lastly, there is nothing quite so important as a trader’s confidence. The more you use paper trading, the more experience you gain and more you understand the intricacies of buying and selling stocks, the more confident you will feel when you actually take your first step into real world trading. 

Shortcomings of paper trading

While there are plenty of positives to paper trading, there are also some limitations that you need to consider. 

Unrealistic trading execution: as you are not risking any real capital in your trades, you may attempt unrealistic or especially risky trades that you otherwise would have avoided if you actually had anything to lose. This can potentially lead to developing ineffective trading habits. 

Trade slippage and commissions: paper trading via a market simulator does not reflect the hidden costs that you will be dealing with when you take on real world trading. For example, you won’t be accustomed to general commission prices on your trades or trade slippage. 

Overconfidence: if you find that your paper trading activities have been fruitful, you may start to become overconfident or even complacent when it comes to your real world trades. Again, as you are not using any real capital in paper trading, you may execute successful trades that were risky and that can lead to inflated confidence.