What Is Paper Trade?
A paper trade is simulated trading which allows investors to practice buying and selling securities without risking real money. While learning the investor can make paper trades and record them by hand to keep track of their hypothetical trading positions and portfolio. However, most paper trading usually involves the use of a stock market simulator, which looks and feels like an actual stock market.
Paper Trade Benefits
The proliferation of online trading platforms has increased the ease and popularity of paper trading without the commitment of actual capital. Online brokers such as Scottrade, Fidelity, and TD Ameritrade offer clients paper trade accounts. Investopedia provides a free stock simulator for paper trading uses.
Another benefit of a paper trade is that it can be used to test a new investment strategy before employing it in a live account. To get the most profit from paper trading, an investment decision and the placing of trades should follow real trading practices and objectives. The paper investor should consider the same risk-return objectives, investment constraints, and trading horizon as they would use with a live account. For example, it would make little sense for a risk-averse investor to paper trade in the same way as a day trader and make numerous short-term trades.
- Simulated trading allows investors to practice buying and selling.
- Paper trading can test a new investment strategy before employing it in a live account.
- Many online brokers offer clients paper trade accounts.
- Paper trades teach novices how to navigate platforms and make trades, but may not represent real market conditions.
Paper Trade to Test Order Types and Market Conditions
Investors and traders who wish to paper trade should familiarize themselves with various order types such as stop-loss, limit and market orders. Also, learning through paper transactions should use multiple market conditions. As an example, a trade placed in a market characterized by high levels of market volatility is likely to result in higher slippage costs due to wider spreads compared to a market that is moving in an orderly manner. Slippage occurs when a trader obtains a different rate than expected from the time the trade is initiated to the time the trade is made.
Paper Trade Accounts vs. Live Accounts
Paper trading may give novice investors or traders the impression that trading is relatively easy. Further, the practice may provide a false sense of security and often results in distorted investment returns. This nonconformity with the real market is because paper trading does not involve the risk of real genuine capital. Also, paper trading allows for basic investment strategies such as buying low and selling high, which are more challenging to adhere to in real life but are relatively easy to achieve while paper trading.
Paper Trade Psychology
Investors and traders are likely to exhibit different emotions and judgment when risking real money which may lead them to irrational behavior when operating a live account. For example, consider a real trade by a new foreign exchange trader who enters into a long position with the euro against the U.S. dollar ahead of nonfarm payrolls data. If the data are much better than expected and the euro drops sharply. The trader may double down in an attempt to recoup losses in a paper trade as opposed to taking the loss as would be advisable in a real trade.
Real World Example of a Paper Trade
For example, TD Ameritrade offers paperMoney®, which is a simulator that allows you to trade in a real-time environment without risking real money. This simulator essentially gives you the opportunity to try options and different strategies without the worry of losing any money.