What is paper trading?
Advertisements for paper trading are scattered all over the internet by exchanges to attract new traders. Paper or demo trading is the process where market participants use virtual portfolios to carry out their executions. It holds no risk for traders as no real money is involved.
Before any developments in the fintech industry, traders used to carry out their demo trades by writing them in a notebook. The current era holds live feed and simulators to help increase your consistency.
When you are paper trading, the brokerage contains orders within their network instead of sending them to liquidity providers. Almost all brokers offer demo accounts to get a taste of their services which a trader can easily access within a few minutes by signing up.
Advantages of paper trading
Paper trading has the following benefits for traders:
- Learning. Novice traders or even amateurs can use paper-trading for learning purposes. Professionals can test out new trading strategies or expert advisors before proceeding onto live.
- No risks. There are no risks whatsoever. Traders can top up their accounts whenever they hit margin calls. You can open demo portfolios with your email id in a few minutes, and there are no KYC requirements or the need to deposit any cash.
- Testing exchange. You can test out various accounts such as ECN, standard, or micro that your broker offers. Take notes of spreads, trading tools, number of available pairs, and trading platforms.
- Experiencing. It is possible to get a taste of trading specific markets or instruments. A trader can choose to demo trade futures, currencies, stocks, and many more on dedicated platforms brokers offer.
Disadvantages of paper trading
While the demerits are as follows:
- Emotions. There are no real emotions involved. As psychology constitutes a significant portion of trading, leaving your feelings unchecked can be detrimental once you trade with real money.
- Real environment. Trading on a demo account does not respect actual market liquidity. There can be slippage or delay in executions in live conditions. Automated robots can especially give a difference in performance.
Should you trade using demo accounts?
Institutional traders and investors advise beginners to paper trade but only for a particular duration. There are a few things that a trader must keep in mind.
Performance difference
Shifting to a live portfolio from a demo will show a negative difference in output. Expect your trading consistency to drop a few percentages as emotions, and other market conditions take over. To ensure that the gains are maintained, treat your paper account the same as live.
Practicing
Paper trading accounts should only be used for practicing and learning purposes. After developing a good understanding of the brokerage, strategy, automated software, and tools, shift over to the actual portfolio.
FAQs
Which settings should I apply in demo accounts?
Use similar settings as you would do on a live portfolio. For example, if a trader plans to employ an expert advisor with $10000 in initial equity and no spreads he should select an ECN demo account with a corresponding deposit amount.
For how long should you keep trading on paper?
Top traders do not recommend demo trading for more than a month. Using virtual portfolios for a long duration can develop negative habits which can be hard to shed off later.
Is it possible to make money through demo trading?
Demo trading portfolios use virtual cash to trade instead of real; therefore, making money is impossible. Some brokers offer paper competitions where you can compete against others for winning actual bucks.