Paper trading can be used to test a strategy and see if it’s profitable, or even just get comfortable with a platform and learn how to accurately execute orders or navigate the charting features.

 

Paper trading can be looked at as training before trading for real (along with real financial risks).

 

If you’re still wondering what paper trading is all about and how to benefit from it, then read on. We’ll go through the basics in this post.

 

 

 

What is Paper Trading?

Paper trading (or sim trading) allows a trader to essentially play the role of a trader without taking the financial risks.

 

Sometimes paper trading can be done on simulated or historical data, but it is usually executed with live market data—whereas the previously mentioned methods fit more into the idea of backtesting. You can read more about backtesting in our article The Complete Guide to Algorithmic Trading.

 

 

 

Pros of Paper Trading

Paper trading gives traders the opportunity to prepare themselves before trading the markets. The benefits of Paper trading are twofold:

 

Practise

 

Paper trading allows traders to practise properly executing their strategy, as well as learning how they react to various market environments that they may have not previously anticipated or experienced. It also allows them to understand the platform; how things like the charting or the potentially dangerous one-click order placing tools work. 

 

Practising with paper trading can give the trader that extra confidence that they are properly prepared to actively participate in the zero-sum game that is financial market trading. A trader should be able to make money on paper before attempting to make money in a live environment. 

 

Testing Strategies

 

Having a method for approaching the market is vital when trading, otherwise you are lost and won’t know how or when to take a position. This is where your trading strategy comes into play. But it’s hard to know what works and what doesn’t without trying it for yourself first, unless you’re willing to just take any and all advice at face value—something which is usually a bad idea in this industry. 

 

Paper trading allows traders to formulate, test, and gain experience with their strategies before applying them to the live market with real money. This method of testing will also give the trader vital insights into how they will react to upswings as well as drawdowns. It’s one thing to see the results of a backtest over 1 year in a single equity curve graph, but it’s another to experience the swings in the days, weeks, and months that the line represents.

 

 

 

Cons of Paper Trading

Despite the very positive advantages, paper trading also has its disadvantages that must be noted to truly gain value from its application.

 

Lack of Emotional Impact

 

Since no real money is on the line, the trade will not experience the very real emotional impact of making and losing money. The loss aversion bias is a well-known effect caused by the fear of losing money. After a string of losses, some traders might find they are unable to follow their trading plan and execute trades.

 

Greed is also a big deal, with a winning streak potentially giving the winning trade a false sense of confidence which may lead to overtrading or trading too large.

 

When paper trading, you can basically trade however you like with no real consequences. If you lose everything, you can just reset your account with a fresh balance of imaginary trading capital. But if you’re winning, you’re still not taking into account the difficulty of following your trading plan and not being swung by emotions when trading with real money.

 

No Slippage or Commissions 

 

Another downside to paper trading is that trading costs such as slippage and commissions are usually not taken into consideration. In some cases, this can be the difference between a profitable and a losing strategy. There are countless examples of strategies that are only profitable on paper but are net losers when applied in reality due to commissions. However, commissions are usually quite clear and easy to calculate into your strategy when paper trading.

 

Slippage is another issue, and often much more difficult to calculate into your strategy. But there are a few ways you can approach this. If your strategy only uses limit orders, then you won’t suffer from slippage. However, limit orders are not always guaranteed to be filled, so it is difficult to know if the trade would have actually executed or not when paper trading. 

 

However, if you are trading market orders (including stop orders), then you will be susceptible to slippage. The amount of slippage that would be experienced is impossible to accurately predict without actually making the trade in the real market, but you can make some assumptions depending on the size you will be trading relative to the market’s liquidity. The thicker the market, the less likely you will experience significant slippage (especially if you are not trading huge size). But if you are trading micro stocks with positions of many 1000s of shares, then the price you are trading when paper trading might not be the price you would get if you were trading with a real position in the market.

 

 

 

Conclusion

While paper trading misses some of the nuances of trading in a live market environmen with real money, it still remains a great way to get comfortable with a trading platform and test a new trading strategy. 

 

Bookmap’s Replay / Simulated Trading Run Mode allows traders to train on historical market data by pausing, rewinding, fastforwarding, and taking positions. It also includes a queue simulator to accurate recreate how the execution of your orders might be affected by liquidity in the market. 

 

Try it out for free today. Click here to get started.