Paper Trading Benefits & Pitfalls
Paper trading is a process wherein you can make investment decisions without actually putting real money on the line. It is a simulation of specific investment market, where you can observe the results of your investments and learn from any mistakes you make, without losing anything. Many brokers offer paper trading to their clients, to help them get used to the trading platform, get a feel and familiarity with the process and terminology, and understand how to study charts and analyze real time data to make an informed investment.
Please note that most paper trading environments will not be 100% accurate, in that many times an order will be executed for amounts which may not really be available on the real market. Additionally, emotion, or psychology, plays a huge role in investment decisions. When the fear of losing money is removed from the equation, as it is in paper trades, the end result can be vastly different from reality. Paper trading is a good way for fresh traders to get rid of the fear and uncertainty of trading financial products and derivates, while at the same time learning the actual process of placing orders and studying relevant data. It should not be mistaken for real market experience.
Paper Trading Tips & Tricks: Most brokers will set you up with $1 million demo paper trading account. Now this is where it starts going wrong. If you want your paper trading account to mirror your real situation, you should ask the broker to reduce the amount to an actual amount which you intend to start with. For example, if you have $20,000 as initial capital for your investments, then reduce the demo account to $20,000.
Even if you think you have identified a juicy pick, do not go all out to try and make maximum profit with a huge amount. Think what you would do if you really had to shell out the same amount. Would you invest $1000 or $10,000? Again, the key here is to try and mirror what you do in reality.
Often times, a demo account will allow you to place orders, and sell, in quantities not really available. This leads to a false impression that you know what you are doing. To avoid this, try to find the real status of an order fill before you paper trade. Would the same order, for the same amount, be actually available on the real market?
Focus more on learning how to use the software and all the tools that the broker provides, without making elementary mistakes. The investment decisions and trading is actually a secondary aspect, as far as paper trading is concerned. There is nothing that can replace real world trading, and you would be better advised to use paper trading to become familiar with the process of trading, rather than trying to make a profit.
Do not spend too much time in this simulated atmosphere. Trading is as much about habits, as it is about information. Once you pick up a trading habit, it becomes increasingly difficult to shed it. And if this habit does not produce any overt problems in paper trade, you could get used to it, resulting in major damage when you start trading with real money.
In summary, paper trading is like learning to swim in the shallow end of a pool where you can stand on your feet. You won’t really learn to swim unless you get into the deeper end of the pool, but you can use the shallow end to get rid of the fear of drowning. Use paper trading if you know absolutely nothing about trading, but do not put too much faith in the performance of your fictional investments.