If you want to practice trading without all of the risk and potential money loss, there is a way to get your feet wet and still hold onto what’s in your wallet.
Imagine simulated trading that allows investors the ability to buy and sell securities without risking any real money. This is known as paper trading and it’s important to use this to sharpen up on your trading skills.
While learning the how-tos and the tips and tricks of navigating the stock market, paper trading allows the extra elbow room to make mistakes and learn from them.
Think of it as a skydiving simulator before actually jumping out the plane.
While learning the ropes, you’ll make paper trades and record them by hand to keep track of their hypothetical trading positions and portfolio. What’s both awesome and kind of scary if you forget that it’s a simulation, is that most paper-trading goes hand in hand with a stock market simulator, which both looks and feels like a real stock market.
The simplest way of paper trading is to identify an appealing stock through a chart on a website or an analysis by a market personality, write down the ticker (a device that shows stock symbols and numbers to convey information about trades), and choose a time to place a hypothetical buy order or sell order (if you’re looking to short sell).
You would then jot down the opening price if entering at the start of the session, or you’d watch the chart and ticker during the trading day to pick a spot that looks like a good entry.
There is considerable variation in the time and entry price, depending on the basic tutorials used to learn to trade. The same can be said of the management phase, as when deciding where to place the stop and how long to hold the position. Whatever your particular approach may be, an exit price is finally written down and you will then repeat the process as many times as needed to collect data for analysis of your progress.
It’s through this progress that you’ll learn your strengths and weaknesses and become a better investor.
A nice tip is that while paper trading on a normal sheet of paper and with a pen or pencil works just fine, think about the ease that comes with using a spreadsheet. A spreadsheet offers a more powerful analytical tool for the detail-oriented. This is because of the added benefit of additional columns for a smooth comparison. And you’ll be comparing quite a bit: Like stop placement, time of day, volume, sector, holding period, day of the week, and market internals (ex. Index direction and market volatility).
In terms of benefits, the ease of access and popularity of paper trading has increased thanks to the proliferation of online trading platforms, add to that the lack of commitment of actual capital.
In fact, online brokers like TD Ameritrade offer clients paper trade accounts.
Another benefit is that through paper trading you can test out new strategies and see what works for you and what doesn’t before jumping headfirst into a shiny new investment strategy and losing a bunch of money.
If you want to get the most of paper trading, make sure that investment decisions and the placing of trades follow real trading practices and objectives. This is all about being well prepared for the real thing, so all the variables should be there for the most realistic experience. As a paper investor, you should consider the same risk-return objectives, investment constraints, and trading horizon that you’d use with a live account. Think of it this way: If you are a day trader, you wouldn’t trade in the same way as a risk-averse trader while paper trading. It wouldn’t serve for your kind of trading.
Remember, it’s better to fail in paper trades than it is to fail in an actual market where money is lost if all goes wrong. So practice for the kind of trading and investing you plan on doing to get the most out of paper trades.
So what are the differences between paper trade accounts and live accounts? Well, paper trading can give off the idea that trading is relatively easy, to novice traders. It can also provide a false sense of security if not taken seriously. This can result in distorted investment returns. All of these factors are a result of the absence of the risk of genuine capital loss while paper trading. There is also the fact that paper trading allows for difficult strategies such as buying low and selling high to be done without the notorious challenge that comes with that in a real trading scenario.
If we were to delve even deeper, there’s also a psychological element to paper trading that you could/should take into account. Due to the fact that there is no risk of real capital in paper trading, a trader will not react with the same emotion and risk management that they would if they were trading in a real market. It’s a symptom of the fact that paper trading offers a risk-free environment where the trader is not blinded by greed and fear, two emotions that pop up a lot in trading and can lead to mistakes in risk management. Paper trading allows for you as the trader to focus on the process and not the pitfalls, therefore sharpening your skills.
This is why it’s advised to take your paper trading as seriously as if you were trading in a real market. You’re trying to practice real strategies and risk management in a simulated environment and that won’t be as effective if you treating it as a game or doing things you wouldn’t do in a real trade situation.
All in all, you need this kind of sandbox environment as a first time trader in order to create a trading system and gain a group of strategies and skills that works for you. Without this crucial step in your stock market journey, you may be prone to developing bad habits that take a longer time to identify and break, than if you simply had a safe space to analyze and correct them. Paper trading allows for that and it even can benefit long term traders as well in this regard.