What is Paper Trading?
The term ‘paper trading’ comes from the stock exchange market, where investors who wanted to practice would write their investments on paper and follow the market movements.
The various trading markets attract many new traders, some of whom are long term traders whilst others are looking to make shorter term trades. Common to all new traders is some understandable hesitation and concern at losing money from their trading.
Whilst any type of trading has its risks, brokers offer a variety of tools to help first time traders to improve their trading skills. One of them is called “paper trading”, although you are less likely to hear the term, since in the online trading industry it is commonly called trading on a demo account.
Over the years, stock market simulators have allowed investors to practice stock trading, without putting real money on the line. This has given investors the chance to determine how their trading strategies would have fared in a live market.
With modern technologies, investors can now easily practice their trading skills and back test their strategies in order to establish their viability. This puts any trader at a unique advantage of knowing how their trading strategies would have performed in real time.
The other benefit of stock market simulator is to enable investors to fully adapt to a broker’s platform. This ensures they can easily navigate and understand the numerous innovative types of trading orders available on today’s robust trading platforms as well as all the features and tools.
Advantages of Paper Trading
Trading without the risk
Demo accounts are widely used by first time traders who want to practice and learn how to trade before they trade with real money. Other users of paper trading/demo accounts are by more experienced traders, who want to test new strategies or practice on new trading channels, learning about the market, and most importantly – learning about themselves as traders. Needless to say, this is a very useful tool in the trading world.
Using a demo account allows first time traders to experience and trade with an account that looks and acts similarly to the real online trading accounts traders use. Demo account users receive an amount of virtual money in the beginning, and can start trading by opening selling and buying positions. Just like a real account, the demo account shows market movements on the traders’ screens, so they can decide if they should continue their trade or get out. At the end of the day they can assess their actions, learn from them and get ready to start trading in their real account.
For demo account users it is not only important to practice on demo accounts, but also look back at their actions and learn from them. This is also important for more experienced traders, who want to practice on the demo account for any reason. They need to check if their trades are as successful as they hoped at the end of the day.
Disadvantages of paper trading
However, there are some risks to paper trading which should not be ignored. Some people would advise not to begin with a demo account for a number of reasons.
The main one, according to them, is the sense of euphoria paper trading can give. Since there is no real money being used, traders can take risks that they otherwise wouldn’t, thus expanding their profits. A case of money loss, on the other hand, is often not taken very seriously since, it’s not real money that’s being lost. There is another disadvantage; since it’s not their money they are trading with, they won’t always follow the market and respond as they would if it was their own money.
Some demo accounts do not use exactly up-to-date information but delay it by 15-20 minutes, so the data is not used by competitors. Others display fake data, but the main goal remains the same – to get traders ready for the Forex market. On the AvaTrade demo account the information displayed is in real-time and projects the accurate rates. The tool is very common and used worldwide by brokers on all types of markets – Forex, stocks, bonds, commodities etc. Due to the fact there is not real money that’s been put in, it’s often called “Paper money”, “Monopoly money” etc.
Should you use paper trading?
Should first-time traders use paper trading? Should they open a demo account before trading in the real market?
The answer is yes, as long as they remember how to work with it properly. There are many reasons that determine whether an investor can have a successful trading career, but the most important one is proper education.
A trading simulator is the perfect learning tool to ensure that one will eventually make a successful transition from demo trading to live trading. Used efficiently, a trading simulator will allow an investor to fully understand and learn their trading psychology; to understand their desired risk appetite and mental resilience as well as how to control their emotions so they will not negatively interfere with their trading activity.
Understanding what type of trader you are, and what risk appetite you have, are vital for trading success, and when you get the opportunity to practice stock trading in a risk-free environment, you can take full control of your trading activities.
Here are a few simple guidelines that would dramatically increase the effectiveness of a demo account.
Treat it as a proper real account
This will not only overcome the main obstacle of demo accounts, but will ease the transition from demo account to real accounts. Paper trading might seem easy, but there is an important part missing.
Real trading involves a lot of emotions, which can be a plus since trades are more involved and invested. But this can lead to negative consequences – emotional trading, with no real thought or research and ending with money loss. This is usually not part of trading with demo accounts due to its nature, and as long as this difference is remembered and taken into account, the transition from demo to real will be more successful.
Learn as much as possible
It is highly recommended to practice on a demo account, whilst reading up on the articles and educational blogs concerning the markets you wish to trade. Once you’ve got a good understanding of the trading platform and the markets you wish to trade on you’ll be better prepared for the real market. We recommend using the demo account for a couple of days, while simultaneously reading relevant materials, and then start trading while it is all fresh.
Finally, trading does not suit everyone. Many times people rush to trade, without understanding the platform or market ending up in disappointment, not to mention the loss of money.
It is highly recommended to open a demo account to practice first, and to use paper trading as a mirror to one self in order to answer the following questions – am I ready to trade? Is this market suitable for me? If the answers are yes, it is time to open a real account!