You’ve probably heard the old (and we do mean old) joke: How do you get to Carnegie Hall? Practice.
Hilarious as that joke is (stop groaning), there’s a lot of truth to it. And it may also answer the question, “How do you get to Wall Street?”
It’s important to learn about financial concepts in the abstract. But when you leave the safety of the classroom and hit the stock exchange, theory won’t always save you.
Learning about the free market is one thing; actually working with it is quite another. Many retail investors start their experience not knowing what they’re in for. They understand the rules and principles of stock trading, but they don’t have firsthand knowledge of how certain strategies might work or fail.
There’s a way to get a better idea of how the stock market might behave within the parameters you want to try. It’s called paper trading.
Paper trading is a bit like the fantasy sports of the stock market. Instead of choosing athletes and monitoring their performance, you choose stocks and securities. You watch your “portfolio” as it goes up or down in real time with the actual stock market.
You don’t risk any money in paper trading. It’s all virtual. This gives you the freedom to experiment with stocks, options, forex trading, funds, bonds, and all the other investment vehicles that Wall Street works with.
You can gain a sense of how the market functions with zero risk — at least financially. Your ego might take a hit or two, but your bank account won’t. Here’s how paper trading stocks can help you.
What is Paper Trading: The Definition
“Paper trading stocks” is a phrase that harkens back to the era before online trading was around. Hopeful investors used to simulate investment strategies on paper. They followed stock price movements and calculated profits and losses without risking any actual money.
The internet made paper trading accessible to more people. Retail investors now simulate stock portfolios electronically. Many online brokerages offer paper trading right on their sites with interfaces that resemble the real thing.
Paper trading happens on the live market, parallel to the real action taking place. New and inexperienced investors get to understand the patterns of the stock market before buying in. Even veteran investors use paper trading to find the most effective new strategies and test out ideas.
How It Works
Every paper trading service, whether it’s through a brokerage or some other source, has different focuses and functions. But the template is basically the same. Here’s how paper trading works.
Get the “Money”
After you sign up for paper trading, the service provides you with stacks of fake cash. The amount varies among different “brokers,” but many seem to go for round figures like $100,000 or $1,000,000.
Those amounts are, of course, much higher than the funds most retail investors have in their real brokerage accounts. The effects on virtual accounts will likewise be overstated to some degree. Relax: It’s only a game.
Once you’re set up with your account and your mountain of hypothetical money, it’s time to start trading. You buy and sell the same way you would in an actual trading session.
Although you’re playing with fake money, you’re simulating using actual data. Your investments rise and fall, following what’s going on in the stock market at present. So if you’re practicing day trading, buying and selling frequently throughout one session, you’d get the most out of it by playing when the New York Stock Exchange and Nasdaq are open for business. (That’s 9:30 a.m. to 4:00 p.m. Eastern, Monday through Friday, except on holidays.)
Some sites let users take part in simulated after-hours trading. This can be very handy for those looking into premarket trading, forex trading, and other alternative strategies that predominate when U.S. markets are closed.
Watch Your Account “Grow” (or “Fall”)
Results are the heart of paper trading stocks. Your portfolio bears the effects of all your investment strategies. The prices of your holdings fluctuate just as they do in the real world.
The results you get from paper trading serve as a basic indicator of how your ideas play out in real life. You’ll use these results to fine-tune and sharpen your strategies as you go.
How It Differs from the Real World
Paper trading stocks is great practice. But it does have some striking distinctions from how the actual stock market works.
No “Technical” Issues
Whenever you trade for real with an online brokerage, your order is sent to an exchange. That’s where your transaction is “matched” with another trader, probably with an algorithm. If you place an order to “sell” a position, the exchange hooks you up with someone looking to “buy” that same position (and vice versa).
This doesn’t happen with paper trading. Everything is virtual, including the “trader” you’re trading with. The reason that’s important to remember is that real-life transactions can run into issues beyond your control.
The paper trading “bubble” doesn’t account for things like technical outages, long queues of investors in front of you, and so forth. These occurrences aren’t very common in real-life trading, but they have happened. Paper trading doesn’t replicate them.
Your Results Will Vary
With paper trading, it’s easy to become a Wall Street killer. Especially with the inflated amount of “money” at your disposal, you may experience big gains from auspicious strategies. These can be very encouraging.
But when you trade with actual money, you probably won’t use the same psychology you have as a paper baron. If you do, you might find yourself getting alarmed when a certain stock goes down in price. The discrepancy can be emotionally disturbing — and emotion is the #1 enemy of sound investing.
The way to combat this dissonance is to approach paper trading exactly as you would actual trading: As a practical and intellectual exercise. You’re free to try out multiple strategies and various instruments in paper trading. Treat them all with the same circumspection as you would in the real world. Leave emotion out of it — although we’ll not stop you from having the occasional fun.
Pros and Cons
Like any investment method, there are benefits and drawbacks to paper trading. Let’s take a look at what these are.
Advantages of Paper Trading
The biggest benefit of paper trading, at least for new investors, is that it helps them get familiar with the stock exchange. It can help to demystify the complex nature of the investment market.
Just like everything in like, stock trading takes practice. There are nuances and strategies that separate novice traders from experts. Paper trading gives beginners a stress-free chance to execute all of the tactics and vehicles they learn about.
Practicing does more than educate you on the functionality of the stock exchange. It also breeds confidence, something that’s vital when one starts working with real funds.
Paper trading helps you to learn how to leave all of the other emotions out of investment decisions, which is crucial to success. It brings you face to face with the data and statistical patterns that you need to make better choices.
Paper trading also helps users to get fluent with their trading platforms. Every brokerage has its unique interface. Trade execution varies from site to site. Paper trading helps investors to understand the mechanics they’ll be working with when it’s time to lay down actual money.
Disadvantages of Paper Trading
One thing paper trading doesn’t explicitly address is how the stock market in general influences the price of individual securities. Most stock prices move in tandem with general market conditions.
When the Dow Jones rises or falls, most traditional stocks do as well. If the Nasdaq booms or crashes, most tech and innovator stocks follow suit. Paper trading doesn’t factor in this effect. It doesn’t explain how the indexes affect more specific securities. It also minimizes the influence that algorithms have on the stock market.
Simulations tend to underplay market fluctuations. While paper trading rightfully helps users limit their emotions, it doesn’t account for other people investing emotionally. Even though that’s an unprofessional and ineffective way to trade, the reality is that many investors still do it, and it has an impact. Paper trading doesn’t reflect others’ lack of discipline.
But these limitations are comparatively minor. Everything you know how involves learning in a setting separate from the real world. You don’t start learning how to drive by being thrust onto the freeway — you have to start in a controlled environment. Most of the “cons” about paper trading have to do with what the user expects to get out of it.
Gorilla Trades: The Real Thing
At Gorilla Trades, we don’t play games we can’t win. We’ve helped real investors like yourself find real stocks that return handsome profits. Our data-driven stock picks are based on years of hard-earned experience and focused research. With over 20 years of practice and customer satisfaction, we have what it takes to win in the real world. Start a free trial to learn more.