Paper trading is a great way to start learning how to trade stocks without risking any real money. In the video below, Steve with FloatChecker will go through the benefits of paper trading as well as one of the most important habits you can adopt to improve your chances of success when you move to a live account. Check out our short video now.
Paper trading, also known as a simulated trading account or a demo account, is offered by numerous brokers. TD Ameritrade, Interactive Brokers, Webull, eToro, TradeStation and others all offer a simulator as part of their trading platforms.
The primary benefit of a stock simulator is the ability to practice trading without using real money. But there are a number of other benefits as well. A paper account can help you learn how to setup a platform and execute different types of trades, like market orders and limit orders. Newer traders can enjoy a stress-free virtual environment without the typical emotions of fear and greed that come with real trading. You can test different strategies and some platforms will let you test different financial instruments, such as options. The main point of a paper account is to provide you with the practice and confidence to eventually start actual trading.
The main limitation of simulated trading is that it’s … well … simulated! The use of pretend funds won’t be able to provide the emotional rollercoaster that accompanies real gains and losses. As a result, you might take larger risks than you ordinarily would in reality. It’s been said that moving from a virtual to a live account is like walking a tightrope one foot above the ground and then moving to a tightrope 1000 feet in the air between two skyscrapers. The mechanics of walking the tightrope might be the same, but the emotional aspects are certainly very different!
Another issue is the unrealistic execution fills when you buy and sell a stock. In other words, a virtual account will complete the transaction at the exact price and amount you specify. In the real world, you might find that you enter or exit a position at a much higher or lower price than you expected if the stock is moving fast and seeing a lot of volume. This is more commonly known as “slippage” and it is not usually accounted for in a simulator.
With these points in mind, the most important practice you can adopt when paper trading is to treat your virtual account like you would your actual account. For example, in some instances your platform will start you off with $100,000 or more in virtual funds. But if you plan on opening an account with $5,000 you would be better served to start your simulated account with the same amount. Why? It will force you to take more realistic trades. A larger demo account may tempt you to take larger risks with increased share sizes. And as our video shows, larger share sizes can result in steep losses very quickly if you take such risks in a live account. As a new trader, such losses will likely trigger a wave of emotions that can result in overtrading and even greater losses. To avoid such an unfortunate outcome, we suggest you start out with realistic paper trades and slowly size up as you gain confidence. Then, once you go live, you’ll be better able to handle the emotions that come with real gains and losses.
To give yourself the best chance of success, treat your paper trading account with the same respect you would a live account. Practice taking profits and keeping your losses small. If you do experience a large loss, take trades with smaller share sizes and then start increasing the share size as you regain your confidence.