Paper Trading - Useful or Useless in 2023?
Let's settle the debate
Paper trading, or trading with simulated money, has been a subject of great debate in the trading community. Some see it as mandatory “training wheels” before you use real money, while others find it useless and even potentially harmful.
This huge divide might be confusing, so let’s find out whether you should or shouldn’t be paper trading in 2023:
Why Paper Trading?
In trading, the only way to improve and succeed is to acquire relevant experience. This means experience that directly makes you a better trader - it includes studying charts, backtesting, and most importantly, live trading.
If you paper trade, you’ll get this experience without risking any capital. Failure and losses are a part of the learning process, and paper trading helps you navigate this phase without damaging your financial or mental state. This is why many traders recommend paper trading for a certain amount of time before using real funds.
You are able to test different strategies and build an edge before risking anything. Once you have a profitable strategy in your paper account, you can switch to a real account and keep following this strategy. You’ll turn your paper profits into real profits.
Sounds great! A risk-free way to make big bucks… right?
Unfortunately, this doesn’t work. You’ll be disappointed if you transition from paper trading to real trading and expect the same results. There is a huge discrepancy between the performance of traders on paper accounts and real accounts, for two reasons: emotion and market mechanics.
When transitioning from paper to real money, it’s nearly impossible to not experience emotion. The paper account isn’t real, but a real account involves the use of real money - the kind you need to sustain your life.
The numbers you see going up and down are your hard-earned cash. The way you approach risk and make trades will be affected, even if you believe it won’t. Emotional control is a skill that must be mastered, and that can’t be done properly by paper trading. Some traders may falsely believe they’re skilled because they’ve done well on a paper account, but have none of the emotional control required to trade with real funds.
Another pitfall of paper trading is market mechanics. In real trading, if you place a limit buy order at a certain price, let’s say $50.00, you are placed in a queue behind other orders at the same price. For example, if there are 90 shares in the queue and you want to buy 10 shares, your order would be added to the end of the line.
This means there are now 100 shares at $50.00. It's possible that the market drops down to $50.00, fills 70 shares, and then immediately turns back up. In this case, the remaining 30 shares, including your order, would not be filled and the market would have moved on without you (sadly).
A paper account would instead show that your order was filled because it can’t replicate real market mechanics. Paper trading does have its limitations. It can be useful for testing out ideas or getting market exposure, but it is not the best method for learning how to trade.
Until a few years ago, trading required a significant amount of capital. Commissions were high and many brokers had minimum account requirements, such as $1,000-$10,000. The PDT rule restricts day traders from making more than 3 trades per week unless they had $25,000 in their margin accounts.
It's difficult to trade when you lose $10 by default in every trade from commissions, and you need a huge amount of money to sustain your inevitable losses until you're profitable. This is why paper trading was recommended before real trading. There was a lot at risk for the average person.
Today, this has all changed. You can open an account with any amount, and commissions are often $0 or extremely low. You even have fractional shares and micro-lots, so you can trade virtually any asset. Trading has become democratized. The barriers to entry are the lowest they’ve ever been.
In my opinion, this makes paper trading obsolete. You can open an account with $50 and risk $0.10 per trade by trading micro-lots and fractional shares. It'll take forever to blow your account. Even if you do blow it up, it's only $50, as opposed to the tens of thousands of dollars in life savings that people lose in the markets.
The choice is clear when it comes to choosing between a paper account or a small real account. You can start at $0.10 of risk per trade, then move up to $1, $5, $10, $100, and $1,000 once you get the hang of it. There’s no difficult switch from paper to real because it was always real. You can comfortably scale at your own pace, allowing a steady glide to success.
Disclaimer: Any content from this newsletter should not be taken as financial or investment advice, but for informational and entertainment purposes only. This newsletter simply shares my personal opinions. Investing in stocks, bonds, futures, options, and other securities carries significant risks. Some or all capital may be lost. With leveraged instruments, losses may exceed initial capital. Past performance of a security does not guarantee future results. Consult with a registered financial/investment professional. This newsletter and its authors are not licensed financial/investment professionals. By reading and using this newsletter, as well as any other publications, you are agreeing to these terms.