Day trading has become extremely competitive and high speed and algorithmic trading is booming in the markets. The good news is that many online brokers have set up paper trading accounts to help traders improve their skills before raising real capital.
If you are thinking of becoming a day trader, it makes sense that you first get some realistic practice to test the waters.
Paper trading is a way to simulate trading strategies and see how they would actually pay off or not.
Online brokerage platforms allow for increasingly sophisticated paper trading capabilities through demo accounts or as a feature for their existing clients.
What is paper trading?
Paper trading is another term for simulated trading, whereby people can buy and sell securities without risking real money. While trading strategies can be refocused, traders can be tempted to use prior information to make current trades, known as predictive bias, although the wrong supporting data set can lead to survivorship bias. Survivorship bias is the tendency to view the performance of existing funds on the market as a representative example.
Investors can simulate trading with a simple spreadsheet or even pencil and paper, but day traders would have a hard time manually recording hundreds or thousands of trades per day and their profits and losses. Fortunately, many online brokers and some financial publications offer paper trading accounts for people to practice before committing real capital to the market. This allows them to test strategies and practice using the software itself.
Establishing a day trading account
Ideally, day traders should trade their paper with the same day trading broker they plan to use for their live account, as it will be as close to reality as possible.
When looking for the best place to practice your trading, consider paper trading platforms that offer live streams of the market before starting with real capital. This is important because you want to be able to trade without delays in feeds or order processing.
The most popular brokers include Interactive Brokers and TradeStation, both of which are fully featured simulators that work even using their automated trading rules. Day traders using these platforms will need to open an account to use the simulator, which may involve depositing minimum funding requirements. The good news is that traders can use the simulator before making live trades with their capital.
Online brokers like Fidelity and TD Ameritrade offer paper trading accounts to clients. Investopedia provides a free stock simulator that can be used for paper trading and for those who want to get started with a day trading account, Investopedia has compiled a list of the best stock brokers for day trading to make the process easier.
It is important to note that there are still some differences between simulated trading and live trading. On a technical level, the simulators may not account for slips, spreads or commissions which could have a significant impact on day trading returns. On a psychological level, traders may have an easier time adhering to the rules of the trading system without real money online, especially when the trading system is not working well.
Paper Trading Tips
The practice of intraday trading largely depends on the strategy that is used to trade. For example, some day traders focus on “feel” and have to rely solely on paper trading accounts, while others use automated trading systems and can date hundreds of systems before paper trading, but the most promising ones. Traders should choose the best brokerage platform for their needs based on their trading options and paper trading on those accounts.
When trading on paper, it is important to keep an accurate record of trading performance and track the strategy over a fairly long period of time. Some strategies may only work in bull markets, which means traders can be caught off guard when a bear market enters. It is important to test many stocks in different market conditions to ensure that your strategies hold up successfully and generate the highest risk-adjusted return.
Lastly, paper trading is not an isolated endeavor. Day traders should regularly use the paper trading features in their brokerage accounts to test new and experimental strategies that allow them to access the trading markets. Simple mistakes can be very costly for day traders who risk thousands of dollars on hundreds of trades a day. This makes paper trading an integral part of long-term success.
Paper Trade Benefits
Getting started with a paper trading account can help you shorten your learning curve. But there are other benefits besides getting educated. First, you take the risk. Because you are not using real money, you lose nothing. You can analyze the mistakes you have made and help create a winning strategy. This also helps you build your confidence, allows you to practice the techniques and strategies necessary to be a successful day trader, including taking profit or loss and pre-trade preparation. Finally, it takes the stress out of trading. You can focus on your strategies in a relaxed environment and take the feeling out of trading.
Disadvantages of paper trading
While paper trading will help you get the practice you need, there are some shortcomings. Because you’re not using real money, you can’t think about how fees and commissions affect your trades. These simulators do not accurately reflect the reality of the markets, as well as the pros and cons of trading. Therefore, it is important to remember that this is a simulation environment where your trading skills are tested.
If you are a first time investor, take as much time as you can in paper trading before you jump on a boat and start trading live. Be sure to explore different strategies and new ideas so that you feel comfortable. The idea behind using simulators is to feel comfortable and reduce your learning curve.
Once you feel like you’ve mastered everything you can do with a simulator, try trading a stock that has had predictable execution, a lower price, and a consistent response to market conditions. If you start trading a highly volatile stock, it can be challenging. But if you choose something safer, you can practice what you’ve learned without taking too much risk.
Day traders face stiff competition to successfully identify and execute trading opportunities. Fortunately, most online brokers offer paper trading functionality that allows day traders to practice their skills before generating real capital. Traders must take advantage of these features to make costly mistakes and maximize their risk-adjusted returns and long-term returns.