Paper trading is the practice of choosing and tracking stocks without actually using real money. Some people literally paper trade by writing their trades on paper, while others use paper trading services offered by trading websites. A while back I was going through a few blogs and articles on the subject of paper trading. Some of the writers were for the practice, while others didn’t seem convinced of its practicality.
Those who spoke for it, see it as a good way to make the transition from just being interested, to actually putting money on the line. Those that are against it argue that you can’t understand trading until real money is on the line.
While I agree with the naysayers, I’m an advocate of paper trading. I have a few reasons why.
For one paper trading gets new traders used to the mechanics of putting on trades. This is especially true if you’ve practiced trading on a particular web based platform, and then use the same one when you start live trades. You’ll know what boxes to check, where to enter your figures, and what mistakes you often make.
Paper trades allow you to test out trading systems. You watch the markets and wait for certain signals. Those signals could be technical signals generated by charts or software, or fundamental trading signals (eg. Fed announcements, or changes in price to earnings ratios, etc.). The signal tells you to buy and sell at certain times. Paper trading gives you a chance to see it your trading tactic could be profitable in current market conditions.
When no real money is on the line you can better get used to following your system, even when you’re losing money. This is something that is difficult to do when your money is on the line, so practicing the steps of following a system when you have nothing to lose, makes it a bit easier to follow it when your money is being put into the same system. At this point it will be easier to cut your losses, learn the value of setting stops, and letting your profits run.
This period will give you a realistic view of what trading is. You’ll see how slowly profits can build, and how quickly losses can accumulate. Trading is not exactly like they show in the movies on most days, unless you watch slow movies that take months to end.
Paper trading is a good introduction for prospective traders, and for all newly introduced trading systems. It’s a good testing ground. It’s like training in anything else. In trading you’re trying to take money from other people. Many of them have years or decades of experience in this game. The least you could do is practice a bit before entering the ring.