Paper trading: Complete beginner’s guide

When you start to learn about trading, how do you check that your system is profitable or not?

Without testing your trading system, it is very risky to put real money into the trade. Paper trading helps you to test your trading strategy, without risking your real money.

So, let’s find out how to use this method and improve your trading in the stock market.

What is paper trading?

Paper trading is a simulated trading method that helps beginners in the stock market to learn and practice trading without putting their own money at risk.

The reason it is called paper trading is that it is done on paper. And you don’t even need a trading account for the same.

Actually, before we had the benefit of stock simulators to help in testing, this was the only method.

What you do when paper trading is that you look at real-time market data and decide about your trades.

You note down on a paper (trading journal) about the trade you took, with stop loss and target (if that is there in your trading system).

And when you close your trade or exit your position, you note down that too.

Now, without risking your money, you have traded in the stock market and also if your trade was profitable or not.

How to paper trade in stocks

• First, you decide the base capital with which you will trade and note it down in your trading journal.
• Select the stocks/index futures of your choice as per the trading system.
• Now, as per your trading system, you wait for the trade to trigger.
• When you decide to take a trade, you note down the price at which you entered the trade and which security.
• When you exit the trade, you note down — the exit price, and profit/loss in the journal.
• Please make sure to deduct the brokerage or transaction fee from that figure for each trade.

The main idea here is to record your trades as close to reality as possible.

Benefits of paper trading

When you are learning trading, especially under a mentor, he will always recommend you to practice it on paper first.

The reasons are the benefits listed below:

Learning about the trading process itself

The very process of recording your trades makes you, a beginner, about the minor but important steps that go into trading in the stock market.

You get to know things like slippage, types of orders, and managing your trades.

Improving skills without risking money

Paper trading apps allow you to show the reality of your trading strategy. When you identify some improvement that needs to be made, you can do that.

And only when you get comfortable with your trading strategy and your learnings, you can try it in a real trading account.

All this is done without risking your main trading capital.

Trying new strategy

Let’s say you read about a new trading strategy. How to test that this is profitable to you?

You can do that by paper trading that strategy. There is no need to include any strategy in your main trading style when you can test it on paper.

Shortcomings of paper trading

Even after so many benefits, there are some shortcomings in this learning process.

Lack of emotional factor

One of the most important factors in trading is the emotional factor. Fear and greed affect your trading decision the most.

In paper trading, your real trading money is not involved, thus there is no fear of losing your capital.

Lack of this fear allows to paper trade perfectly. And, when you shift to real-world trading, these emotions are strong. They do affect your trading.

This leads to many new traders complaining that their trading system failed when they traded with real money.

All the orders are perfectly executed

Though current stock simulators try to execute your orders in as much real-time as possible, the reality is all the orders get executed.

This doesn’t always happen in real life.

In real trading, it is normal that your order gets executed at a price that is slightly above or below the intended price. Even in the case of a limit order, sometimes the whole order is not executed and you have to modify it.

Then there is a reality of a volatile market when terminals can hang or orders are stuck. These are the things, that never happen in paper trading.

Final thoughts

Beginner traders (as well as investors) can benefit hugely from paper trading if they use it as a way to understand how trading and investing work.

It is an important tool to test the waters when you are just learning about stock market terms.

The only thing you need to be careful about is maintaining a trading journal so that you can measure and improve your skills.

Frequently Asked Questions