What is Paper Trading and Why Does it Matter?

Lots of people feel an urge to play professional tennis. It would be over-hasty, however, to pursue this goal by calling up Roger Federer and challenging him to a match next Sunday. Someone who decided to do this would likely be so overwhelmed by the pace and skill of the competition that he’d give up on his Wimbledon dreams within seconds. A more realistic approach would involve working one’s way up among less intimidating opponents, until the pace of the professional tennis match became his own norm. And then, one fine day five years from now, he might actually be able to trot out onto the court and face off with the man himself.

So it is for someone interested in trading online. If you simply sit him down before a computer screen, set up his trading account, and order him to start opening deals, the result could be to turn him off online trading for life. Quickly losing a chunk of one’s own money in an online trading scenario can be disheartening enough to do this. Fortunately, we live in an age that doesn’t require trial by fire for novice traders. There’s a great tool you can use to build up your confidence as a trader without having to put any real money on the line: paper trading. This is a trading simulator that gives you the power to freely open and close deals, knowing quite well that, if those deals don’t pan out the way you hoped, your savings will still be intact.

What is Paper Trading?

In the traditional sense, paper trading means taking a piece of paper and writing down the opening price of a security you’re interested in trading. Thus begins a kind of rehearsal of the act of trading in the asset, which should be followed by close monitoring of the security’s progress throughout the day. Finally, at the point where you would close your deal, you write down the exit price and calculate the success or failure of your hypothetical undertaking.

The more modern – and better – way of doing this is through using an online demo account, provided by your trading platform, that simulates the experience of actually trading in that security. This is like a proper dress rehearsal for the opening night at the theatre. When Nvidia shares go up in real life, you’ll be notified of this on your demo account, just as live traders are on their accounts. You’ll also receive up-to-date price quotes, news feeds, and stock charts on your asset just as they do. You’ll practice using different order types, like stop loss or take profit. You’ll open your deal in exactly the same way that you eventually will on your live account, and, after employing your own fabulous strategy, you’ll close the deal too.

Pitfalls of Paper Trading

The main pitfall in paper trading accounts lies in not using them for what they’re meant for, which is accustoming yourself realistically to functioning under the stresses of real trading. Therefore, if you filled your demo account with $2 million when you actually intend to trade with $1,000, this would be foolish. Remember, you want all the conditions to approximate the real thing as much as possible. The same limits, risks, and pressures that will beset you during the real trading experience should be present when you’re paper trading. This implies you shouldn’t, while paper trading, spontaneously decide to ignore your plan and open a huge deal with half your trading capital. It also implies that, in the event your deal turns sour, you don’t just laugh it off. You have to psychologically put yourself in the position of having your hard-earned money on the line! It should upset you if the plan breaks down.

Who Should Consider Paper Trading?

Paper trading is not only for novices, though they certainly have a lot to potentially gain from it. Anyone who wants to experiment in trading with an unfamiliar asset or an unfamiliar order type would do well to try it out on a demo account first. This would be a wise course of action, especially since the forces influencing forex prices are not the same ones pulling the strings behind stocks or commodities. In addition, an experienced trader who has yet to use a certain trading platform could give it a go with a simulator to see how it feels. It’s a great idea to use the paper trading platform offered by the broker you intend to open an account with, because this will approximate the trading experience you’ll be facing much more closely than an unrelated platform.

Online traders often want to practice technical analysis methods that they’re learning. A paper trading account is the perfect place to do this, especially since it can tend to take a few tries before getting these techniques right. All the way through an online traders’ career until the very end, a demo account is undeniably a useful ally. The reason is that he is constantly finetuning his strategy and learning new skills, (or, at least, he should be). 

How to Go About Paper Trading

We’ve mentioned the importance of entering, as much as possible, the psychological space of a real trader when you do your paper trading. If, upon faithfully employing your strategy in the paper trading setting, things turn out badly and you feel terribly inadequate, it’s a sign things are going perfectly according to plan. The best thing that can happen to you when demo trading is realizing the flaws of your analytical process, your plan, your instincts, and your control of your moods. And there aren’t many people in the world who have no flaws to come to terms with.

Ideally, then, you’ll realize how far you are from being ready to go out there in earnest. Simply pick up the ball again and give it another go with your demo account, using your carefully considered and improved techniques. You may well discover some positive points about your strategy that you want to keep. If you’re really serious about making yourself into a trading success story – and, if you’re not, maybe you should be – keep a journal of your thinking before and after opening your deals. Write down why you chose to enter at this point. What happened during the session? Did you face a dilemma about how to react? And, most importantly: Where did you go wrong?

Special Considerations

The kind of confidence you want to gain through paper trading is the humble kind. A demo account works to give you a heads-up about parts of the real-life process that are going to be a challenge when the time comes. The truth is that no electronic platform can simulate the feeling of really having your money on the line, but it undoubtedly helps, at the least, to have a blueprint in your mind of what needs to be done and which parts of the activity could prove to be obstacles. By way of comparison, astronauts find the feeling of weightlessness on the moon very different from their training, when they tried out walking at the bottom of a swimming pool, but the hours spent in a wetsuit, at least, gave them a few hints of what to expect up there.

When paper trading, employ your strategy with discipline. You need to drill into yourself the habit of following your plan down to the smallest detail. This will be much harder when real cash is on the line, so you’d better get used to it now. If you fling your plan out the window in the desperate attempt to make up your losses, you won’t be the first one to have done so. This inner battle with fear and greed is part of what online trading is for everyone else too, so start coming to terms with your tendencies now, before the heat starts building up.

Summing Up

Paper trading is one of the fruits of our technological age you should grasp with both hands and put to good use. Wouldn’t it be nice if we could use simulators to train for the other challenges in life, like marriage or parenting, before going out there and trying them with real people’s emotions in the line? At least when it comes to money, then, why not put yourself through some “astronaut training” before you blast off into the financial markets, just to see how you hold up? Perhaps, indeed, online trading is not for you, and you’ll come to that realization through experiencing the dress rehearsal.

Before jumping to that conclusion, however, give paper trading a good, honest try and keep on using it as long as you need to, until you feel comfortable. For many people, it can provide that bridge between the imaginary and the real that they need to propel them with confidence into the live trading arena.