Paper Trading: How to Practice Trading without Risk

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Paper trading is a trading method that enables you to learn the ins and outs of playing the market at your own pace. In essence, it’s a simulated experience in which you practice placing fictitious stock market orders and testing trading strategies without the stress or risk of real trading.

If you’re wondering why it’s called “paper” trading, the phrase dates back to a time when investors scribbled stock prices on paper before analyzing them and the terminology stuck. Fortunately, the emergence of online trading platforms has made paper trading much more sophisticated and practical. That means, no more scraps of paper flying around!

Key takeaways

Paper trading offers a realistic, risk-free environment to practice trading and develop skills without risking real money.

Paper trading is not just for beginners. Experienced traders can (and do) use it to test new strategies and improve their skills.

Being successful at paper trading is no guarantee that you’ll be successful when it comes to real trading.

WARNING

Trading exposes you to the risk of losing more than your initial investment and incurring financial liability. Trading is suitable only for well-informed, sophisticated clients able to understand how the products being traded work and having the financial ability to bear the aforementioned risk.

Transactions involving foreign exchange instruments (FOREX) and contracts for difference (CFD) are highly speculative and extremely complex. As such, they are subject to a high level of risk due to leverage. Please keep in mind that CDF trading is banned in the US.

Information published on the NewTrading.io website is for educational purposes only and should not be construed as offering investment advice or as an enticement to trade financial instruments.

Paper trading vs real trading: How are they different?

Real trading involves making real financial transactions with real money, which can expose you to real potential losses. Conversely, when you’re paper trading, you’re not using real money, so any losses are only hypothetical.

Traders usually trade “on paper” before they begin trading for real

But practicing on a free trading simulator—no matter how realistic—also has a significant limitation: You’re not using real money. So, you won’t truly experience the pressure, psychological biases and emotions that factor into actual trading.

If you plan on opening a real trading account later, it’s better to do it gradually, starting with spot trading (trading without leverage).

Paper TradingLive Trading
Risk-free, simulatedReal financial risk
Strategy testing, learningActual trading with potential gains/losses
No financial loss, educationalReal market experience
Lacks emotional realismFinancial risk, emotional stress
Beginners, strategy refinementExperienced traders, real investment

How to start paper trading

1. Choose the right platform

The players that offer paper trading break down into two major types: online brokers and trading simulators. 

Since online brokers often use “demo accounts” as a pretext to making a sale, it’s usually best for beginners to opt for an unaffiliated trading simulator.

Criteria for selecting one of the best trading simulators:

  • Currentness
    Opt for stock market data feeds that provide accurate real-time updates.
  • Free
    There’s no need for you to pay to start using a good unlimited trading simulator.
  • Features
    Look for a simulator that allows you to reset your balance, place a wide range of stock
  • market orders, and access analytical tools.

2. Set up your paper trading account

While some trading simulators don’t require creating a user account, we advise creating a free account, so you can save your preferences and results from one trading session to the next.

Set up your account with a realistic starting balance and simulated trading expenses. Also, remember to stay realistic about available options, especially when it comes to leverage and trading hours.

Your first trading session should be dedicated to familiarizing yourself and getting comfortable with the simulator. During this first session, press every button, pull every lever, and flip every switch. 

Ask yourself “What does this do?” about everything you see. Explore each nook and cranny and place every kind of stock order you can think of before resetting your balance. You’re trying to get all your mistakes out at the beginning, so they won’t come back to bite you in future practice sessions.

3. Develop a trading plan

The biggest risk of paper trading is becoming a compulsive trader, but if the money isn’t real, why not do it all just for an extra dose of fun?

There’s no harm in going all out with a paper trading account, but just be careful not to fall into bad habits. Playing at “casino trading” is not going to help you become a better trader, and it could cost you dearly when you transition into real trading.

Paper trading should be a time to learn good habits and develop your trading skills. And nothing will help you more in building those things than keeping a detailed trading journal. 

Put your whole plan in writing: strategic vision, objectives, trading rules, and so on. Formalize your trading plan as you reflect on your paper trading experience and look to apply the trading lessons you’ve learned during that time.

4. Take a step back and carefully scrutinize your performance

Is your paper trading account in the black? Are your profits soaring? Don’t let it go to your head! You need to consider several things to keep your performance in perspective.

Beyond the additional difficulties inherent in real trading, particularly increased stress, psychological bias, and emotional burden keep in mind that your trading environment is probably not entirely realistic.

Have all fees and expenses been applied against your return? Are the execution levels of your stock market orders realistic compared to the actual order book? Has the applicable investment tax been taken into account?

Finally, even if you’ve enjoyed a winning performance, you still must overcome one final series of obstacles to confirm your ability to beat the market.

5. Explore the backtesting features

When it comes to paper trading, going back in time is indeed possible! 

Backtesting allows you to test a trading strategy on historical data, analyze its behavior, and measure its performance.

Since a paper trading account is not confined to the present, you can practice on an almost unlimited number of scenarios and market situations, testing your strategies against past events like historical crises, speculative bubbles, and range phases.

Just beware: No matter how successful your backtesting goes, past performance does not guarantee future results. Applying a trading strategy that was successful in a specific situation in the past could still backfire and expose you to vulnerabilities arising from even the slightest change in market conditions.

After analyzing your paper trading performance, adjust your strategies based on your findings. 

Remember, paper trading is a learning process, so don’t be afraid to make mistakes and experiment with different approaches.

Steps to adjust your strategies:

  1. Identify shortcomings: Figure out areas where you struggled or made errors. Look closely at your trading journal to determine any patterns.
  2. Learn from your mistakes: Try to understand the reasons behind each mistake, and then use this knowledge to fine-tune your trading methods.
  3. Incorporate improvements: Implement improvements into your trading plan based on your analysis and new knowledge.
  4. Test your adjustments: Before committing real funds, continue to paper trade and evaluate the adjustments you’re making.

By focusing on analyzing your performance and adjusting your strategies, you’ll find yourself better equipped and more confident when it comes time to tackle real-world trading.

FAQ

How can beginners get started with paper trading?

Before you begin, make sure you understand the basics of the stock market and trading strategies. Once you’re ready, you can create a hypothetical portfolio without investing actual money. Lots of online brokers and trading platforms offer paper trading options that simulate real trading for beginners. Set up a virtual account and start tracking and recording your trades to gain experience.

Do paper trading results reflect what would happen in real trading?

Paper trading provides a valuable simulation of real trading, but it’s crucial to remember that no simulation is perfect. While it can offer insights into your trading skills, the results of paper trading might not always accurately reflect real-life trading outcomes, because your emotions and reactions to changing market conditions can play a significant role in actual trading. While paper trading is an excellent way to learn and practice, it’s always important to approach real trading with caution and be mindful of the potential differences.

author
Maxime Parra

Maxime holds two master’s degrees from the SKEMA Business School and FFBC: a Master of Management and a Master of International Financial Analysis. As founder and editor-in-chief of NewTrading.fr, he writes daily about financial trading.

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