What is paper trading?
Paper trading is more commonly used in an institutional setting. It is what we in the forex trading or CFD industry call Demo Trading. The term ‘paper trading’ comes from the stock market, where investors who wanted to practise would write their investment ideas on paper and follow the market movements, to see if their ideas panned out.
There are many types of traders, including more short-term and those who keep positions open for the longer term. Common to all new traders is hesitation when it comes to placing trades and of course, concern at losing money from their trading.
Whilst all types of trading come with risks, brokers offer a variety of tools to help first time traders to improve their trading skills before committing real funds. One of these tools is called “paper trading”, although as mentioned you are less likely to hear the term, since we use the term demo trading .
Advantages of Paper Trading
Trading without the risk
Demo accounts come with many benefits and are widely used by first time traders who want to practice and learn how to trade before they trade with real money. More experienced traders use demo accounts to test out their strategies or to test-drive a new platform they haven’t used before. For new traders it is an excellent way to learn about the market, and most importantly to learn about yourself as a trader. Needless to say, this is a very useful tool in the trading world.
On the downside though, for a new trader, trading in a simulated environment without committing real funds, feels very different from a real account scenario where real money is at stake. With demo trading, the psychological aspects of trading don’t come into play, like fear and greed.
How it Works
Using a demo account allows first time traders to experience and trade with an account that looks and acts similarly to the real online trading accounts traders use. Demo account users receive an amount of virtual money in the beginning, and can start trading by opening selling and buying positions. Just like a real account, the paper trading account shows market movements on the traders’ screens, so they can decide if they should continue their trade or get out. This all contributes to assessing their actions, learning from them and getting ready to start trading in their real account.
For demo account users it is not only important to practise on demo accounts, but also to look back at their actions and learn from them. This is also important for more experienced traders, who want to practise on the demo account. They need to check if their trades and strategies proved to be as successful as they had hoped, and of course, they will use this knowledge to optimise their performance on the back of it.
Disadvantages of paper trading
However, there are some risks to paper trading which should not be ignored. Some people would suggest not to begin with a demo account for a number of reasons.
The main one, according to them, is the sense of euphoria paper trading can give. Since there is no real money being used, traders can take risks that they otherwise wouldn’t, thus expanding their profits. A case of money loss, on the other hand, is often not taken very seriously since it’s not real money that’s being lost. There is another disadvantage; since it’s not their money they are trading with, they won’t always follow the market and respond as they would if it was their own money.
Some demo accounts do not use up-to-date information, but delay it by 15-20 minutes, so competitors do not use the data. Others display fake data, but the main goal remains the same – to get traders ready for the Forex market. On the AvaTrade demo account, the information displayed is in real-time and projects the accurate rates. The tool is very common and used worldwide by brokers on stocks, bonds, commodities etc. Due to the fact that there is not real money that’s been put in, it’s often called “Paper money”, “Monopoly money” etc.
Should you use paper trading?
Should you as a first-time trader use paper trading? Should you open a demo account before trading in the real market?
The answer is yes, as long as you remember how to use it to its best effect. A few simple guidelines can dramatically increase the effectiveness of a demo account.
Here are a few simple guidelines that would dramatically increase the effectiveness of a demo account.
Treat it as a proper real account
This will not only overcome the main obstacle of demo accounts, but will ease the transition from demo account to real accounts. Paper trading might seem easy, but there is an important component missing.
As mentioned briefly earlier, real trading involves a lot of emotions, which can be a plus since traders are more invested emotionally. But this can lead to negative consequences – emotional trading, with no real thought or research and ending with money loss. Again, with demo trading you may feel the adrenaline rush and the fear or the greed. So as long as you factor this in, the transition from demo to real will be more successful for you.
Learn as much as possible
It is highly recommended to practise on a demo account, whilst simultaneously educating yourself on the market. There are so many free blogs and education portals you can use. Don’t underestimate the importance of a strong understanding of the trading platform and the markets you wish to trade on. Preparation is key. We recommend using the demo account for at least a few days, before switching over. You can also use our trading calculator in order to estimate the possible outcome of a trade before entering it. Finally, remember that trading does not suit everyone. Those people that rush to trade without considering the intricacies of the platform or the market may end up disappointed, not to mention ending up with lighter pockets.Use paper trading as a mirror to yourself, in order to answer the following questions – am I ready to trade? Is this market suitable for me? If the answers are yes, it is time to open a real account!
Paper Trading main FAQs
Why is paper trading important?
Paper trading gives you something approaching hands-on experience, which is far more valuable than simply theoretical knowledge. You can be a genius with theoretical knowledge, but when faced with the pace of movement in real market trading environments you could freeze-up and fail miserably. So, paper trading can teach you valuable lessons about real-world trading that you can’t learn from other sources. And while paper trading won’t fill in all your learning needs it is one zero-risk method for improving on your trading.
Who can benefit from paper trading?
Paper trading is considered to be very useful for new traders, but in truth it can benefit anyone, even professionals use paper trading when they are developing a new strategy. And while you might be impatient to get to trading with real money, the benefits to be gained from paper trading are incalculable. Taking the time to test your trading strategy with paper trading could mean the difference between a profitable trading career, and a huge disappointment. Paper trading can also help remove the emotions from your trading since you aren’t risking real money.
How can you get the most from paper trading?
Paper trading without a plan isn’t going to help you much in the long-run. You have to treat your paper trading just as carefully as you would handle real money trading. That means instead of starting with the $1 million demo account you’ll likely be faced with, you should start with a realistic amount of money in your demo account. That might be $10,000 or it might be $1,000. Then you need to record everything about your trades. Why you took the trade. What your exit target is and why. What actually happened with the trade. Afterwards you can go back to determine how you might have made the trade more profitable, or less of a loss.
Paper trading account
So now it’s time for you to open a paper trading account. Start testing out the different trading strategies and techniques we talk about in our education section. You can start by identifying trends and then using simple moving averages, before moving up. Try and spot your own emotional reactions to different trade outcomes, as understanding how this affects your trades will be a massive advantage in improving your skill level prior to risking real money.