Paper trading is a useful tool for both beginners and advanced traders, as well as new investors who want to familiarize themselves with financial markets.
In theory, paper trading can build insight and improve skill sets at every step in a trader's journey, from novice to market professional. But does it really work as intended, or are there better ways to develop ideas and strategies? What are the key benefits and limitations, and how can market novices get the most value from the experience? Finally, can paper trading hurt financial performance, rather than help it?
In this article, we provide a definition of paper trading and explain how it can teach you what you need to know to feel more confident about trading on live markets. If you want to start right away, follow our quick guide below.
Develop your paper trading skills with CAPEX.com
- Practice risk-free trading with $50,000 virtual funds
- Gain access to educational content on CAPEX Academy
- Learn how to make informed trading decisions with our integrated tools
- Test strategies on the go with our free mobile apps
What is paper trading?
Paper trading is a way for people to learn an effective way of dipping their toes into how complex financial products such as stocks, foreign exchange (FOREX), and futures without using real money. It teaches trading chart patterns and fundamentals as well as money and risk management under real market conditions.
Before the wide availability of online trading platforms, new traders would write out hypothetical trades on paper. Paper records were used to track potential positions, strategies, profits, and losses without risking real money in the stock market.
These days, there’s no longer a need to record trades on paper, as online trading platforms offer virtual practice accounts that aim to replicate the look and feel of their live trading accounts.
These trade simulators offer the most potent approach to paper trading because they allow setting up workstations that mimic actual real-time market conditions. Traders can also get to know the features of the trading platform and track their progress so that they can feel more confident once they start in a live account.
For active traders, “Winning” is about finding different strategies that get rewarded with hypothetical profits. For long-term investors “Winning” is about equalling or exceeding the performance of a benchmark index.
Brokers now offer this service for free to customers, letting them use the same trading software as real money players. This connection is invaluable because it allows a seamless transition from a simulated into an actual trading environment once the student is ready.
Who Should Try Paper Trading?
People who would most benefit from paper trading options include:
New traders
People with no experience in the market would gain invaluable trading experience by paper trading for several weeks or more. The experience and knowledge gained after paper trading could prepare a novice for trading in a live, funded account.
In the real markets, inexperienced traders can be hesitant to take profits or execute stop-losses in the hope that prices will rise and they can make larger profits or recoup losses. Paper trading offers new or even experienced traders a way to develop their skills and test setups to gain confidence in a trading approach without the pressure of risking real funds.
Discover how they work before starting paper trading:
Those with no CFD trading experience
Many traders and investors have little or no CFD trading experience. These market participants could benefit considerably from paper trading using a demo account to practice before starting to trade derivatives in a live account.
CFD trading is leveraged, meaning you must put up a percentage of the cost of the position as a margin, to gain exposure to the full value of the trade. It’s important to remember that potential profits and losses will be magnified, as they will be calculated on the full size of your position – not just the margin.
Paper trading is one of the best ways to gain trading experience, but online trading courses can provide key knowledge and insights needed during practicing:
- Trading strategies such as day trading, scalping, swing trading, price action, Elliott Waves
- Chart patterns, including Japanese candle patterns like Doji, Pin Bar, Triangles, Head & Shoulders, Double Top and Bottom
- Trading indicators such as MACD, RSI, ADX, ATR, Bollinger Bands, Stochastic, or Ichimoku
- Support and resistance levels such as Fibonacci retracement, Pivot Point, Moving Averages
Experienced traders
Traders with experience could paper trade to test new trading strategies, try out a different underlying market like cryptocurrency, or see how an existing trading plan might perform under different market conditions.
Changes in the market could also prompt an experienced trader to use a paper account to test out new strategies based on the new market dynamics. Traders can also test new asset classes.
To make better-informed paper trading decisions, consider the following market outlooks:
How to Increase the Effectiveness of Paper Trading?
Paper trading is inherently different from live trading. As a result, a simple guideline to increase the effectiveness of paper trading is to treat it as a real trading account.
To get the most benefits from paper trading, an investment decision and the placing of trades should follow real trading practices and objectives. The paper trader 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-taker short-term trader to buy and hold assets, or for a long-term investor to practice numerous short-term trades like a day trader.
Also, paper transactions can be applied to many 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 price than expected from the time the trade is initiated to the time the trade is made.
Investors and traders can use simulated trading to familiarize themselves with various order types such as stop-loss, limit orders, and market orders. Charts, quotes, and news feeds are available on many trading platforms as well.
In a virtual account, traders can set a virtual balance like what they plan to invest in real life and monitor how it would perform. They can start with small positions and gain experience to feel more confident in scaling up to larger ones.
A good paper trading account will update asset prices in real time and will simulate a paper trade in the same way as a real trade would be executed. The idea is to have an experience that is as close as possible to live buying and selling.
Traders can record their trades in a trading journal and analyze the data to determine what works, what doesn’t work, and how to improve before they start live trading.
Pros and Cons of Paper Trading
Let's outline the key benefits of paper trading, looking at the ways it shortens the learning curve so that novices have an advantage when it's time to play the game with real money.
Advantages of Paper Trading
Paper trading offers the following advantages:
No Capital Risk
Paper trading does not cost/involve money, and you do not lose money with poor trading decisions.Developing Trading Experience
You can practice trades and gain experience on the entire trading process.Developing Strategies
Paper trading can be used to test whether a new trading strategy works.
Developing Confidence
When an individual paper trades successfully, it helps build confidence to eventually conduct real trades.Reduces stress
Without having to commit money, paper trading is relatively low stress and not as emotionally taxing versus live trading.
Disadvantages of Paper Trading
The following are disadvantages to consider when paper trading:
Euphoria Trading
As real money is not involved in paper trading, an individual may execute trades and take risks that they would not normally do with a live account.Trade Slippage
A “hidden cost” in real-world trading, slippage is not reflected when paper trading. This may cause paper trading returns to be skewed to the upside.Emotional Reality
Emotions when paper trading is inherently different than when trading in a live account due to the lack of capital risk. As a result, paper trading does not evoke emotions that would be felt when trading.Overconfidence
An individual can develop an overconfidence bias through paper trading, which could carry into live trading and adversely impact trading results.
Where to start paper trading?
For a virtual trading practice environment that's close to the real thing, you can’t get much better than the simulated trading and investing platforms offered by actual working online brokerages. These practice accounts typically mirror the broker’s working trading platform.
Most are free, although they may require you to set up a trading account. The best forex and CFD brokers or traditional stockbrokers give test drivers access to a fully functioning setup with the same tools that active customers use. You’ll often see demo accounts described as ‘paper trading’, which is the term to describe simulated securities trading.
A CAPEX.com demo trading account will enable you to see thousands of financial markets available and get used to how they behave.
You’ll be able to set alerts on markets you want to keep an eye on, so you can react instantly to any price volatility. The demo account will also help you get used to the CAPEX.com platform, ensuring that you can read and analyse price charts, fill in the deal ticket and monitor open positions.
Is Paper Trading Worth It?
Paper trading can make someone a better trader and investor, and there is no financial risk involved. After someone has been paper trading for several weeks or more, they will likely move over to live trading. The period someone should take before moving to real trading will depend on their experience and the hours, they dedicate to a paper trading account beforehand.
One downside to paper trading is a disconnect from the real markets. Since there is no actual money in jeopardy, paper traders tend to perform actions that aren’t necessarily a representation of their true risk tolerance.
Free Resources
Before you start online trading, you should consider using the educational resources we offer like CAPEX Academy or a paper trading account. CAPEX Academy has lots of free trading courses for you to choose from, and they all tackle a different financial concept or process – like the basics of analyses – to help you to become a better trader or make more informed investment decisions.
Our paper trading account is a suitable place for you to learn more about CFD trading, and you’ll be able to get an intimate understanding of how trading and investing work – as well as what it’s like to trade with leverage – before risking real capital. For this reason, a demo account with us is a great tool for investors who are looking to make a transition to leveraged trading.