What is Paper Trading & How Does it Work?

June 28, 2023

What is paper trading?

Paper trading, also known as virtual or demo trading, refers to the practice of simulating trades without risking real capital. It involves creating a hypothetical portfolio and making investment decisions as if you were trading with real money. The term 'paper trading' originated in the days before electronic trading when novice traders would practice their skills on paper. Beginners will use a paper trading platform to learn how to invest, and more experienced investors may use paper trading to test out a brand new strategy.

How paper trading works

In the realm of paper trading, everything mirrors the real-world trading environment as closely as possible, except that no real money changes hands. Traders can choose among stocks, ETFs, options, futures, and more, to build and manage their virtual portfolios.

The process involves selecting a security, deciding the number of shares to buy or sell, and executing the trade. The trading platform then tracks the performance of these trades over time, giving the user insight into how their decisions would have panned out in the real market.

When you get started using a paper trading platform, it will feel just as if you are trading in the real-world. These platforms may not completely mimic the costs of participating in trading, but they will certainly help you understand the process.

Pros of paper trading

There are several advantages to paper trading, making it a preferred method for both beginners and experienced traders:

Risk-Free Learning: Paper trading offers a risk-free environment for beginners to learn the basics of trading and understand market dynamics. It provides an opportunity to learn from mistakes without incurring financial losses.

Testing Strategies: Experienced traders often use paper trading to test new strategies before implementing them in the real market.

Understanding Market Mechanisms: Paper trading helps traders understand different aspects of the market, such as bid-ask spreads, market volatility, and impact of news events on stock prices.

Familiarity with Trading Platforms: Paper trading allows users to familiarize themselves with trading platforms and tools, making the transition to live trading smoother.

Cons of paper trading

While paper trading is a valuable tool, it does have certain limitations:

Lack of Emotional Involvement: The absence of real money means there's no emotional risk, which can lead to more reckless decisions that wouldn't be made in real trading scenarios.

Delayed Market Data: Some paper trading platforms use delayed market data, which may not perfectly replicate live trading conditions. If you are thinking of building a paper trading platform, consider Intrinio as a market data provider. Intrinio specializes in affordable real-time market data without any display restrictions or limitations.

Overconfidence: Success in paper trading doesn't necessarily translate into success in real trading. Differences between paper trading and real trading can lead to overconfidence and potential losses.

Platforms for paper trading

Numerous online platforms offer paper trading capabilities. Some popular ones include:

Thinkorswim: TD Ameritrade's thinkorswim platform provides a realistic paper trading experience with most of the features available in their live trading platform.

Interactive Brokers: Known for its advanced features, Interactive Brokers offers a paper trading account where users can practice strategies and learn the platform.

Intrinio: At Intrinio, we understand the value of paper trading, which is why our market data is not only affordable but also accurate and reliable. We provide the necessary tools and data that can be used to create your own paper trading application or to test out your own trading strategies.

Some other companies to check out include WeBull, ETrade, and TradeStation.

Many of these platforms will offer free versions of their paper trading systems, but some do charge a subscription fee in order to practice your trades. Keep your eyes peeled for companies like Intrinio that will give you a free trial so you can make sure their product is right for you.

In conclusion, paper trading is an excellent way to learn about investing, understand market dynamics, and test new strategies without risking real money. There are limitations to paper trading, but if you are just getting started with investing or a new strategy, it’s a worthwhile investment to make.

By practicing in a risk-free environment, you can build confidence, hone your strategies, and prepare for trading in the real-world. If you are interested in taking a free trial of delayed or real-time stock prices data, feel free to chat with a member of our team or request a consultation. We’re excited to help!

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