Paper Trading: What It Is & How It Works
Paper trading is simulated trading that allows investors to practice trading without using real money. Investors who try their hand at paper trading often use an online stock market simulator that looks and feels like a real online brokerage.
What Is Paper Trading?
Paper trading is simulated trading that allows investors to practice trading before they start risking real money. Beginners use paper trading to learn how to buy and sell, while experienced traders may use paper trading to see if a new strategy would be profitable.
Paper trading is usually free, enabling investors to try their hand at buying and selling without risking real money.
Tip: There are many platforms that offer free trading simulators, although some may charge a subscription fee.
How Paper Trading Works
The most basic way to practice paper trading is by using a pencil and paper. Investors can choose a stock and watch the market for an attractive entry point. However, simulated trading through an online platform that works like a real brokerage platform provides more tools and enables investors and day traders to test their strategies.
Many free platforms have delayed security pricing, although some offer trading in real time. Paper trading is generally free, although some platforms do charge a subscription fee. However, there are so many free platforms available that it might make sense to look for a free one. Portfolio simulators often set a starting balance of $10,000 or $100,000, which might be a larger amount than novice investors have to invest.
Paper trading can be a good way to learn how to trade options and many other assets, including foreign exchange, stocks, bonds, and exchange-traded funds. It also allows investors to select different order types (market order, limit order, stop limit or stop loss order, etc.) so that they can test and learn how each one works.
Paper Trading Providers
As with online brokerages, paper trading platforms come in a wide array of features, research, tools, and interfaces. Most online platforms mimic the trading platform from the brokerage that offers them, so it makes sense for investors to select a paper trading platform from a brokerage they want to use.
Here are some common paper trading providers:
- TD Ameritrade's thinkorswim platform with paperMoney
- TradeStation
- E*Trade
- eOption Paper Trader
- Interactive Brokers' TWS Paper Trader
- WeBull
Pros & Cons of Paper Trading
The biggest benefit of paper trading is the fact that it doesn't involve any risk, but the benefits are not limited to that. Paper trading also involves certain issues that investors should also be aware of.
Pros of Paper Trading
- No emotional stress: Aside from not risking any money, paper trading doesn't involve emotional stress like real trading does.
- Novice Investor Education: Investors can learn how to trade and learn about different order types before they start to trade for real.
- Test Strategies: Investors can test their strategies over an extended period of time like a month to see if they work instead of trying them out in the market when real money is at stake.
Cons of Paper Trading
- Real money, and emotions, are not involved: Paper trading doesn't give investors exposure to the kind of emotional pressure that will cause them to make decisions when trading for real. Investors are often affected by their emotions when it comes to making trading decisions, but they don't get any practice dealing with such emotions when using paper trading.
- Doesn't simulate true costs of trading: Paper trading may not simulate the costs associated with real trading, which is affected by price slippage and trading fees with brokerages.
Bottom Line
Paper trading is a great way to learn how to trade or test new strategies, but it's important to understand its limitations. Many brokers have a paper trading platform as part of their services, but investors might have to sign up for a brokerage account to gain access to it.
This article was written by
Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.