When you start investing, you may learn about “paper trading” as a method to test your trading skills.
Some people believe it’s an excellent method to learn and become a proficient trader. Others think it’s a waste of time.
Let’s go over some of the pros and cons of paper trading.
If you have never heard of the term, paper trading is a process that allows you to trade financial instruments without risking any capital. Many brokers offer paper trading when you open an account.
Many other investment news websites also make a paper trading platform available to those who sign up. Of course, it’s also possible to track simulated trades on a spreadsheet, too.
The most significant benefit of paper trading is that no capital is at risk. Also, most trading platforms that offer paper trading do not charge for this service.
In addition, many of these platforms support complicated features, such as shorting and options investing. It’s usually best, however, for beginners to stick with stocks until you get used to how trading processes work.
When you become more proficient at investing you can use paper trading to test out strategies. For instance, if you want to see how small-cap stocks will perform in a portfolio, you can set up a simulated (paper-traded) portfolio with small-cap stocks.
Trading stocks can be intimidating for beginning investors. If your broker offers paper trading in your account, you should consider using this feature. It will help you learn how to place buy and sell orders.
Try the various functions your broker offers, like market and limit orders. Ask questions if you are unsure of any of the services.
By learning your broker’s platform you are less inclined to make mistakes with real money. Executed trades are final and binding. Mistakes can cost you. It pays to understand the platform before putting real money at risk.
Many paper trading websites also run contests frequently. If you do well with your trading you can win money. These contests are usually free to join.
Cons of paper trading
The emotions associated with trading real capital is nothing like you have ever experienced. Newer investors are often overwhelmed after their orders are filled.
The stress occurs with experienced investors, too. They have learned how to deal with it. Paper trading can never capture that emotional rollercoaster ride associated with trading real money.
Getting good fills from your broker takes practice. It’s a combination of knowing the market, the stocks you’re trading, and even getting to know your broker.
If you feel your broker isn’t getting the best fills possible, you can choose another broker. This dynamic is not available with paper trading. You’re likely to always get good fills when paper trading. Not as much with real trades.
Does getting good fills matter? That depends on the type of trading you are implementing. For long-term trades, the fills are less important. Still, you don’t want a broker who deviates sharply from the bid-ask spread.
Some paper-trading platforms consider commissions. If your platform does not calculate the impact of commissions, you’ll have to account for that when you make real trades. Many brokers offer commission-free trading, even on real trades, but that can change.
When you trade in a paper account, you are likely to trade more often than you would in a real account. The chances of finding a stock that skyrockets increases when you trade more stocks of different companies. With real trades you would not have the capital to pull this off.
You are also likely to buy riskier assets in a paper account than you would in a real account. The risk-reward ratio suggests that riskier assets tend to outperform less-risky assets in the short term.