Paper trading is a way for those new to trading to overcome their fear of losing money because they can practise trading with fake money on a demo account.
Like anything, getting some trading experience is key to success and paper trading offers a risk-free way to start with no real money needed. Naturally, the risks are going to be higher when you first start trading without having practised and developed your trading skills. Paper trading helps bridge the gap until a trader is ready to put their hard-earned money to work in the financial markets.
What is paper trading?
The name paper trading is still used today although few new investors actually write anything down on paper. The name is a legacy from pre-internet trading, when a trader or investor would need to call their stockbroker on the telephone and place a trade.
A technique recommended for new traders in those days was simply to write down the trade you would have placed and don’t actually call the brokerage. You would then track the performance of all your buying and selling on paper, as if you had invested a certain amount for example $10,000 and adjust your balance each day according to the paper profits and losses you had made.
This same principal is typically done these days in a simulated environment on the same online trading platform you would use to place real trades. This is typically known as a demo account, short for demonstration.
FlowBank offers a demo account via mobile app or on your desktop PC or Mac computer.
Is paper trading a good practise?
A rookie trader can use paper trading to get themselves familiar with the process of trading and iron out any misunderstanding about how the online trading platform works and the different contracts available to trade.
For example, a simple mistake like placing the wrong size trade can be laughed off as 'part of the learning curve' on a demo account. Were this to be done on a live account, it could put off the new trader rom continuing to trade unnecessarily.
However, it is possible to misuse paper trading and misinterpret the results from a demo trading account as a true reflection of what can be expected in a live account.
Putting it differently, demo trading accounts are very useful to develop new ideas and try new things but the results of any trading strategy conducted with paper trading will quite likely see different results in a live account.
That’s not because the trading platform works differently or the fees are higher, because this is not the case. It is because paper trading is very different emotionally than real trading. The stress of seeing your own real money gain and lose value can alter decision making, often for the worse.
Pros and cons of paper trading
Here we have put together a simple table laying out the main advantages and disadvantages of paper trading and how it can help performance as well as possibly hinder performance.
You can’t lose money – it’s as simple as that
There is much higher emotion attached to buy and sell decisions with real money
With no money at risk, you can sleep easier
Paper trading should be done as if it were a live account to prevent unrealistic results.
Learn the platform
Contract specifications, Order Types etc are best learned on a demo account
Paper results could trick you into missing the bigger picture that is moving market prices
Gaining experience without the risk means there is almost no barrier to entry for new traders
Paper orders are perfectly executed but this isn’t always possible In real market conditions
Seeing what you have learned crystalise with hypothetical profits breeds confidence
Demo trading can see traders assume the future will be just like the past but it normally isn’t
A demo account can provide a no-risk trade history from which to analyse results
Best ways to paper trade
The important thing to do when paper trading is to make the process as realistic as possible, so that the strategy can be best transplanted to live trading.
The main things you will want to write down in your trading journal as well as include in your online order are:
- Reason for trade
- Instrument traded
- Day of the week
- Time of day
- Trade Value / No. contracts
- Entry Price
- Stop Loss
- Take profit target
- Holding period
- Notes on trade result
The idea is then to make note of what works and what doesn’t and adjust these parameters over time in order to produce a set of trading rules.
Of course, there is no need to reinvent the wheel. The best approach is to use a pre-existing trading strategy and adjust it over time according to the results from your own paper trading.
NOTE: Do not stop this process just because you started trading live. It is invaluable even for professional traders and allows a continual development process to become a better trader.
How long should I paper trade for?
One of the most common FAQs for paper trading is: When should I switch from demo to live?
There is no fixed amount of time but if you are practising day trading, you have probably got the best out of the demo trading account after 30 days. After 90-days, paper trading can become more detrimental than beneficial because bad habits based on non-live conditions can be formed and are hard to get rid of.
Keep this in mind. The goal of paper trading is to get to know the trading app or online trading platform and avoid some of the most common trading mistakes. The best way to fine-tune your trading strategy is with a live account and an amount of capital that you are comfortable losing in a worst-case scenario.
What is the best paper trading app?
There are many different choices for paper trading on the internet. Common starting points are using the price data from websites like Yahoo Finance or the Financial Times or using free online chart platforms like TradingView or Barchart.com.
We would recommend that you practise paper trading in as close a way as possible to the live trading experience. FlowBank offers 50,000 financial markets to trade with a top-rated trading app and the security of a Swiss Bank account.
However you choose to paper trade, we hope the above information has been useful towards your trading journey.