Some new traders are so eager to get started that they jump right in without adequate preparation or know-how.
Most importantly, they don’t yet know where their edge is or how to capitalize on it.
Paper trading is an excellent way to climb the learning curve. Paper trading happens in a virtual account that lets you “trade” under real-time conditions; the difference, of course, is that you’re not trading real money.
Most major brokerage firms offer paper trading or demo trading accounts; while the benefits of this training seem obvious, it’s not without its naysayers.
Here’s a look at the pros and cons of paper trading so you can decide if it’s right for you.
Plusses to paper trading
Economics: Paper trading allows you to get started — and to test your strategies — for free. Don’t let the excuse of I’d like to get started with trading but don’t have the money yet hold you back.
Organization: Traders need to be calm, cool and collected, and paper trading lets you familiarize yourself with different order types under reduced-stress circumstances, allowing you to get comfortable setting stops, limit and market orders.
It also gives you time to set up a trading layout. You’ve got limited real estate when it comes to your computer screen (or screens); paper trading allows you to decide if you are helped by having charts, a news feed, a chat room or something else in your face as you’re working.
Statistics: You need stats to figure out your strengths and weaknesses as a trader; paper trading gives you data on the strategies, time frame and more that are working for you or failing you. You could blow through a lot of money trying to find your edge; paper trading lets you collect statistics on your trading without risking real money.
Experimentation: Paper trading isn’t just for beginners. Many successful traders won’t add a new strategy to their trick bag without paper-trading it first, allowing them to experiment without damaging their real account.
Some traders also backtest strategies and ideas; paper trading is often considered a better alternative to backtesting, because it shows how the strategy works in real time rather than plugging it into historical numbers.
Downsides to paper trading
No skin in the game: If we made a bet on a coin toss — heads I win, tails you lose, and the loser has to shave their eyebrows — you’d be mighty interested in the outcome. If it was simply a friendly bet with no stakes riding on the outcome, you wouldn’t really care who won or lost.
Some naysayers to paper trading believe you aren’t serious about trading until real money is on the line. Paper trading mutes the emotions and, according to some, dulls the senses.
You need to know how you will react when a position moves against you, if you will panic, freeze or trade your plan. Even great traders feel fear from time to time, second-guessing themselves; paper trading doesn’t get them past those doubts.
Use paper trading to …
— Learn how to execute different types of orders comfortably.
— Identify your strengths and weakness.
— Build confidence in yourself and your strategies.
An alternative to paper trading
If you are one of those people who need skin in the game to get excited, consider opening a trading account with a small amount of capital. Trading a small account offers the same benefits as paper trading but with the emotional trigger of a real financial investment.
Taken seriously, paper trading can be invaluable. If you think it’s a game and don’t try to learn from it, however, paper trading can be a complete waste of time. It all depends on you; the more you prepare for live trading — and act like you have real money on the line — the better off you will be when there is real money on the line.
Jason Bond runs JasonBondTraining.com and is a swing trader of small-cap stocks.
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