The pros and cons of paper transactions

Paper trading is a simulated market environment in which participants write down buying and selling decisions instead of placing actual orders at a broker. This process can be very simple, jot down a few numbers on a napkin, or it can be very complicated. The spreadsheet breaks down multiple elements into components for reflection and analysis. New traders are often instructed to trade on paper until they learn basic strategies, and many experienced traders use this practice from time to time, especially when researching new ideas and methods.

In theory, from novices to market professionals, simulated trading can build insights and improve skills at every step of a trader’s journey. But it really works as expected, or is there a better way to develop ideas and strategies? What are the main advantages and limitations, and how can market novices get the most value from the experience? Finally, does paper trading really hurt financial performance instead of helping it?

Paper trade method

The simplest paper trading method is to identify attractive stocks through charts on the website or analysis of market participants, write down the stock code and choose a time to place a hypothetical buy order (or a sell order if you want to sell short). If you enter the market at the beginning of the transaction, the novice will note the opening price, or observe the chart and the market on the trading day, and choose an entry point that looks good.

The choice of entry price and time varies greatly, depending on the basic tutorial used to learn the trading game. In the management phase, this is also true when deciding where to stop loss and when to hold a position. No matter which method is used, the exit price will eventually be written down, and the novice will repeat the process until enough data is collected to analyze the progress.

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Although pen and paper are great for paper transactions, spreadsheets provide more powerful analysis tools for detail-conscious individuals because they can add additional columns to capture:

Trading simulators provide the most effective method for paper trading because they allow novices to set up workstations that simulate actual real-time market conditions. Many brokers now provide this service to clients for free, allowing them to use the same trading software as real money players. This connection is invaluable because once the student is ready, it can seamlessly transition from the simulated trading environment to the actual trading environment.

The final method can be used at any time, even on weekends when financial markets are closed. Ask a friend or spouse to randomly select a technical chart, print it out and pass it to you, and cover it with a second sheet of paper on the right. Make sure that the chart contains all the technical indicators you want to use in actual trading. Pick up the second piece of paper and move it to the correct price bar at a time, while you choose where to buy and sell.

Main advantage

Let’s outline the main benefits of paper trading and see how it shortens the learning curve so that novices have an advantage when playing real money games.

  • No risk: It doesn’t cost anything, and you won’t lose money due to the wrong decision or the wrong timing. It also allows you to observe all the flaws in the analysis process so that you can begin the difficult task of building a clearly defined trading advantage.
  • No pressure: Trades can evoke dual emotions of greed and fear, often turning a blind eye to key information needed for effective risk management. Paper trading bypasses this emotional roller coaster, so new participants can focus entirely on the mathematical process instead of pitfalls.
  • practice: Participants gain experience in every aspect of the trading process, from preparation before listing to the final profit or loss. When visiting the broker’s simulator, they learn how to use real money software in a relaxed environment where the wrong keystrokes will not cause financial disaster.
  • confidence: Making a series of complex decisions in return for hypothetical profits can go a long way in building the confidence of novices so that they can do the same when real money is in danger.
  • Statistical data: Paper transactions of a few weeks to a month can build useful statistics about new strategies and market methods. The results can be frustrating, forcing the new trader’s education process to the next step, which in turn requires additional paper transactions and data sets.
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Main restriction

Let us now outline the limitations of paper trading, and if key lessons are not learned, it can hurt the performance of novices.

  • Market relevance: Paper transactions failed to resolve the impact of the broader market on individual securities. Most stocks move in sync with the major indexes during highly correlated periods, which is common when the market volatility index (VIX) rises. Although the results may look great or terrible on paper, broader conditions may create results rather than the advantages or pitfalls of individual positions.
  • Slippage and commission: Real currency traders will deal with various hidden costs from slippage and commissions. Most paper trading techniques do not capture wide spreads well, thereby exacerbating this situation. For example, you think that momentum stocks purchased on paper for $50.00 might cost $50.50 or more in the real world.
  • Emotional reality: Paper transactions will not resolve or evoke the true emotions generated by actual profits or losses. In the real world, many traders cut their profits and let their losses continue due to lack of market discipline. When dealing with hypothetical numbers, those self-destructive calculations will not work.
  • fit: Paper traders choose the ideal entry and exit, ignoring the obstacle minefield created by the modern computer-driven environment. When the algorithm enters a predatory mode and looks for a stop loss point, these shock levels become very obvious to real-world participants.
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Bottom line

Paper transactions allow new participants to perform the key steps of risk-taking, from selecting securities to finally exiting, thereby benefiting them, but the value of this process is limited because it underestimates the impact of the correlation and emotional response of a typical market day-to-day index. In addition, it does not address the impact of algorithmic strategies that usually target people with flesh and blood.

Even so, most novices should spend a lot of time trading their new ideas and strategies on paper, and then use actual capital to take risks and gain as much experience as possible. This work will bring rich returns, shorten the learning curve, and at the same time allow new participants to obtain limited profitability earlier, rather than let new participants miss the opportunity.

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