Paper trading

What is paper trading?
Paper trading is a process in which you make investment decisions without committing real money.

You approach a paper trade just as you would a real trade, taking into account everything you would consider if you were making a real investment, and recording your investment decisions on paper. By looking at how your theoretical investments perform you can evaluate how well your trading approach is working, without the pressures of possible financial loss.

Why paper trade?
Paper trading gives you the opportunity to practise, and learn, without the danger of real losses. You can experiment with different trading approaches, and test and refine your trading strategies before applying them in the market. 

It is also easier for you to be objective in a simulated trading environment than in the real market. When you have real money at stake, emotional reactions can sometimes cloud your judgement. However, if you practise a detached and objective approach during paper trading, you may increase your chances of using such an approach in real trading.

How to paper trade
You should approach paper trading as realistically as possible. Just as you would if you were trading real money, you need to take into account:

  • your financial resources
  • the amount of time you can realistically dedicate to trading
  • your desired exposure to risk.

You will need a source of pricing information so that you can record your trades at market prices. Possible sources of pricing information are:

  • tables of futures prices in the financial press
  • free futures prices, either live or delayed, on the Internet
  • futures prices from an information vendor you subscribe to.

Having formed a view on the market, you then theoretically enter the position chosen to reflect that view. All trade details should be recorded, just as they would be with a real trade. On closing out the position, all details should again be recorded and the profit or loss from the strategy calculated.

Your overall aim is to test the approaches to trading that you are considering. You should set out, in writing, one or more trading plans. The plan should include details such as:

  • profit targets
  • the degree of loss that will trigger an exit from, or adjustment to your position, and
  • other parameters that define your desired risk/reward profile.

Each time you examine your position, ensure that the action you take is in accordance with your trading plan.


Considerations

  • Margin obligations
    When trading futures, it is necessary to take into account margin obligations. As these will be incurred in the real market, they must be factored into your paper trading. You will need to consider the initial margin that would be payable at the time of entering your position, and also the variation margins that would apply on a day-to-day basis.
  • Bid/offer spreads
    When looking at the prices quoted in the financial press or on the Internet, be sure to use the correct side of the spread. If you are selling a futures contract, the bid price should be used; if you are buying a futures contract, the offer price should be used. When valuing the position during its life, you should use whichever price you would pay or receive in order to close the position.
  • Brokerage
    Brokerage will be charged when trades are transacted in the real market, so should be included when calculating the cost of entering or exiting a position.

No guarantee
Paper trading success is no guarantee of success in the real market. It is generally the case that profits are far easier to come by in a simulated environment than in reality. Emotions will be harder to ignore when real money is at stake.

However, if the paper trading process is used effectively, you may increase your chances of success once the real market is entered.