Pros and Cons of Paper Trading in Stock Market

Paper Trading is considered a simulated market environment during which the participant writes down buying and selling decisions instead of placing actual orders at a brokerage. The method is often simple, with a couple of numbers jotted on a napkin, or complex, with spreadsheets breaking multiple elements into parts for reflection and analysis. New traders are often instructed to paper trade until they learn basic strategies. While many experienced traders utilize the practice from time to time, especially when performing on new ideas and approaches.

In theory, paper trading can build insight and improve skill sets at every step during a trader's journey, from novice to plug professional. But does it 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 maximum value from experience? Finally, can paper trading hurt financial performance instead of helping it?

Ways to Paper Trade

The most straightforward approach to paper trading identifies an appealing stock through a chart on an internet site or an analysis by a market personality, writes down the ticker and chooses a time to put a hypothetical buy order (or sell order if meaning to sell short). The novice jots down the opening price if entering at the beginning of the session or watches the chart and ticker during the trading day, picking a spot that appears sort of a good entry.

The choice of entry price and time varies considerably, counting on the essential tutorials to learn the trading game. An equivalent holds during the management phase when deciding where to put the stop and how long to carry the position. Regardless of the approach, an exit price is finally written down, and therefore the novice repeats the method until enough data is gathered to research progress.

While pen and paperwork are perfectly well for paper trading, the spreadsheet provides a more robust analytical tool for detail-oriented individuals because they will add additional columns to capture:

• stop placement

• time of day

• volume

• sector

• holding period

• day of the week

• market internals, including index direction and market volatility

Trade simulators offer the foremost potent approach to paper trading because they let novices find workstations that mimic actual real-time market conditions. Many brokers now offer this service free of charge to customers, letting them use an equivalent trading software as real money players. This connection is invaluable because it allows a seamless transition from a simulated virtual trading environment once the scholar is prepared.

A final approach is often used at any time, even during weekends when the financial markets are closed. Have a lover or spouse pick a technical chart randomly, print it out and hand it to you with the right side covered by the second piece of paper. Confirm the chart has all the technical indicators you would like to use in real-world trading. Take the second sheet and move it to the right one price bar at a time while you select where to shop for and sell.

Key Benefits

Let's outline the critical benefits of paper trading, watching how it shortens the training curve so that novices have a plus when playing the sport with real money.

• No Risk

It costs nothing, and you cannot lose money with bad decisions or poor timing. It also allows you to watch all of the issues in your analytical process so you'll begin the arduous task of building a well-defined trading edge.

• No Stress

Trading evokes the dual emotions of greed and fear, often blinding participants to crucial information needed for effective risk management. Paper trading bypasses this emotional roller coaster. Therefore the new participant can focus entirely on the mathematical operation, not the pitfalls.

• Practice

The participant gains experience in every trading process, from pre-market preparation to final profit or loss taking. When accessing the broker's simulator, they find out how to use existing money software during a relaxed environment, where the incorrect keystroke won't trigger a bankruptcy.

• Confidence

Making a series of complex decisions that gets rewarded with hypothetical profits goes an extended way in building the novice's confidence to do an equivalent thing when real money is at stake.

• Statistics 

Paper trading for several weeks up to a month builds valuable statistics about the new strategy and market approach. The results are likely to be discouraging, forcing subsequent steps within the latest trader's educational process, successively requiring additional paper trading and data sets.

Key Limitations

Now let's outline the restrictions of paper trading and, therefore, how it can hurt the novice's performance if critical lessons are not learnt.

Market Correlation 

Paper trading fails to deal with the broad market's impact on individual securities. The bulk of equities move in lockstep with significant indices during times of high correlation, which is common when the Market Volatility Index (VIX) rises. While results may look great or terrible on paper, broader conditions may have created the results instead of the virtues or pitfalls of the individual position. 

• Slippage and Commissions

Real money traders affect all kinds of hidden costs from slippage and commissions. This is often exacerbated by wide spreads that are poorly captured in most paper trading techniques. For instance, the momentum stock you think that you're buying on paper at $50.00 may cost you $50.50 or more within the world.

• Emotional Reality 

Paper trading doesn't address or evoke real-world emotions produced by actual profits or losses. Within the world, many traders cut profits short and let losses run because they lack market discipline. Those self-destructive calculations don't inherit play when handling hypothetical numbers.

• Form Fitting

Paper traders detect ideal entries and exits, missing the minefield of obstacles generated by the fashionable computer-driven environment. These shakeout levels become only too apparent to real-world participants who have watched dozens of technically sound positions go up in flames when algorithms shift into predatory mode and hunt down their stops.

The Bottom Line

Paper trading benefits new participants by letting them act out critical steps in risk-taking, from the choice of securities to the ultimate exit. Still, the method has limited value because it underplays the impact of index correlation and emotional reactions during a typical day. Additionally, it doesn't address the effect of algorithmic strategies that routinely target the flesh-and-blood crowd.

Even so, most novices should spend a substantial amount of their time paper trading their new ideas and methods before risking natural capital, gaining the maximum amount of experience possible. The exercise can pay excellent dividends, shortening the training curve while allowing limited profitability much earlier to initiate against new participants who expire the chance.