Simply defined, “Paper trading is a simulated trading process in which would be investors can ‘practice’ investing without committing real money.”
Most brokerages offer a form of paper trading, or stock market simulator, so you can practice trading and learn on their platform.
Having a place to practice new strategies, learn new methods of trading, and learn a brokerage’s systems before putting real money on the line is very beneficial. There are, however, a few setbacks when relying on paper trading exclusively. These accounts are based on fake action in the market, which means that your trading could be skewed.
Stock Market Games
Stock market games are a form of stock market simulator. You’ve probably seen them before. A group of people have come together to compete to see who generates the largest return in a set amount of time.
While these games are ‘cute’ and entertaining, they should be avoided whenever possible.
Do not use these games to practice or hone your skills. The objective of these games is to take big risks and hopefully score big rewards to put yourself into first place.
The majority of traders playing these games focus on penny stocks, biotechnology stocks, or earnings plays. These stocks typically pay off the best because they can move 10-100% in a single day. Much like the lottery, the winners are sparse and the losses are plentiful.
The skills needed in these games are not ones that will benefit you in the real market. Unfortunately, we do not start with 100,000 to do with what we want. Instead, our portfolios are typically a lot smaller, usually 99% smaller.
There is also no magic reset button that comes with these games. Make a few bad trades? Don’t worry, you can just wait till the next game starts and try again. Not only do these games teach you to focus on stocks and trades that should be avoided or traded with an extreme amount of caution, but you have zero emotion in the game.
Paper Trading Accounts
A paper trading account is a fake money account run by your brokerage or a market simulator. This is a one-on-one exercise, you are not competing with anyone to be a “top-dog”.
Paper accounts are a great way to start trading. Not only do they allow you to hone and develop your skills but you can make foolish mistakes that won’t cost you any money. Most option traders have spent good money trying to figure out if their position should be bought to open or sold to open. You don’t want to waste good money, especially in a small portfolio, figuring out different order types.
Once you make it through the basics of trading, a paper money account is still very useful. As an option trader, you know trying to understand every option strategy is a lifelong mission. With a paper money account, you can understand how a butterfly or iron condor trades in real-time. This is a great way to take the theoretical information you’ve picked up from an option book and see it in action.
They key with paper money accounts is to keep it as real as possible. If you plan on trading with a $1,000 account, don’t put $100,000 in your fake portfolio. Focus on strategies that you want to trade and on stocks you want to trade.
No matter how much you want it to be like real-life, a paper money will lack emotion. Unfortunately, real trading is an emotional rollercoaster and you can’t simulate that with paper trading. It doesn’t matter if you treat it like real money, you will also know there is a reset button if you really mess up.
How do you deal with emotions with fake money?
It is impossible to take emotions out of real trading. When you trade, it is with your money. It doesn’t matter if this is money you can lose, it is still your hard-earned money. Not only are you in jeopardy of losing your entire portfolio but no other profession will quickly prove you wrong. You can place a position right now and instantly start losing money. It hurts to be wrong. I don’t care how thick your skin is, being wrong is the worst.
When you are trading, do not leave your emotions at the door. Do not pretend that you will not be emotional or that you will be able to get rid of all your emotions. Instead, practice recognizing what emotions are coming into play as you are making the trades. It is best to be able to recognize your emotions and adjust your trading around them.
It is important to know that you are not trying to get so good with paper money that you can simply switch it to live mode and make a lot of money. There will still be learning curve when you make the move to real money; the idea is to shorten the learning curve.
When trading paper money you want to practice until you can develop muscle memory for your trades. You want to develop a pattern of recognizing possible positions, knowing which option strategy you want to use, placing the actual trade, and how to manage it.
When you are paper trading, you are not trading on the actual market. Obvious? Yes, but let me explain.
Even though you are trading real stocks at real market prices, the dynamics of the order fills are not the same. In a real market, there are a lot of different players in the market, market makers, institutions, and people on the other side of your position.
Even though you are getting easy fills at great prices on your paper money account, these fills will not be as easy to get using real money. Slippage, defined on Tradimo as, “The difference a trader expects to pay for a trade and the actual price at which the trade is executed”, plays a big part in getting filled at good prices.
In real money, you will need to account for volume and liquidity in positions. With options this can be seen in volume and open interest. Paper money doesn’t take liquidity into account when placing you in your positions. A paper account will typically fill your order if your price is within the bid and ask.
Favorite Paper Trading Account
There are a lot of websites and brokerages with which to open a paper money account. Our favorite account is with TD Ameritrade. You can open a TD Ameritrade account with no money so you can begin to practice your trading.
If you do deposit a little money into an account, TD Ameritrade will give you real-time quotes. This is huge! Most websites and brokerages will keep you on delayed quotes. These quotes can be delayed 15-20 minutes and can make it very difficult to make quality trades.
TD Ameritrade’s software, ThinkorSwim, is second to none, but it is not user-friendly. Paper trading will give you the opportunity to play, explore, and learn their systems.
Stock market games should be avoided at all costs. They do nothing but promote poor and reckless trading. The only way to win in these games is to take big risks and hope for big games.
A paper money account is a great way to learn how to trade without wasting actual money. I got my start in a paper money account and continue to use paper money when practicing new strategies and techniques.
You can learn the basics like types of orders and option strategies with no skin in the game. Even with practice, you won’t be able to move directly to real money and start profiting. Real money brings in emotions, slippage, and liquidity that you won’t find in a paper money account.
There are many places to open a simulator or paper money account but our favorite is with TD Ameritrade. TD Ameritrade’s simulator is the closest you will come to trading actual money. With their paper money account you can learn their tools and software in a stress-free environment.
What is your favorite place to paper trade? Let us know in the comments...