What is Paper Trading in the Stock Market?

Stock Market Guides is not a financial advisor. Our content is strictly educational and should not be considered financial advice.

Have you heard the term "paper trading" before and wondered what it meant?

Hint: it's not referring to trading reams of printer paper with people.

When it comes to the stock market, paper trading refers to a type of trading that doesn't use real money.

Definition of Paper Trading

Here is a formal definition for paper trading:

In other words, it's like a sandbox for practicing your trades without risking real money.

Paper trading is great for people who are just getting started with stock or options trading. You can buy stocks in a pretend world where there is no financial consequence to you, but where the stock prices themselves still tie to reality.

Imagine you are ready to start trading for the first time, and you buy 100 shares of stock. Then you try to sell 100 shares, but you aren't sure if your order went through. So then you try again to sell 100 shares, and next thing you know, now you're shorting the stock and borrowing money to do so! You can get through the learning curve and work out all those kinks safely in a paper trading account.

It's also great for those who are learning a new trading strategy and want to develop some muscle memory with the process before putting real money at risk.

Stock Market Guides

Stock Market Guides identifies stock and option trading opportunities that have a historical track record of profitability in backtests.

Average Annualized Return

This takes the average return in backtests of all the stock picks featured in this service and annualizes it.

79.4%

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Limitations of Paper Trading

Paper trading is an excellent way to get familiarized with the mechanics of buying and selling stocks and options in a safe environment, but there are limitations.

Paper Trading Can Only Simulate Fill Prices

One limitation is that since you aren't using real money, there is no way to be sure of the exact "fill price" you would truly get for any given transaction. The paper trading software will have to make an assumption, and that assumption might be based on the bid and ask prices at the time, which can sometimes be unrealistic.

For example, imagine you are using your paper trading account to buy a share of stock, and the bid is 100.00 and the ask is 101.00. The paper trading account might indicate you got a fill price of 100.50 (right in the middle of the bid and ask) when in a real account your fill price might be different based on real-time market mechanics.

This issue can be especially pronounced for options, where bid and ask spreads can sometimes be substantial. In Thinkorswim's paper trading platform, we found profits from options trades to be exaggerated compared to actual live trading. It's not necessarily Thinkorswim's fault; it's just one of the challenges that all paper trading platforms have to contend with.

Emotions From Live Trading Can Be Different From Paper Trading

Paper trading offers a great way for people to learn the motions of buying and selling stocks and options. But it may not always offer a true reflection of the emotional charges you'll feel when trading.

One of the toughest parts of trading is the emotional aspect, also sometimes referred to as trading psychology. When money is at risk, many people can end up riding an emotional roller coaster.

Learning to work with your emotions can be a key part of being a successful trader or investor. Since paper trading doesn't involve real money, is doesn't necessarily help you simulate all the feeling states involved with trading.

We Think Paper Trading is a Good Idea

We think it’s a good idea to use a paper trading account at first when you try out our service. This way you can get a feel for how the trades work without risking real money.

It can serve as a great tool for building muscle memory while learning to make these trades. It also helps you see the impact of wins and losses and gauge your own risk preferences without risking real money.

FAQs

My account brokerage doesn’t have a paper trading feature. What can I do?

There are trading platforms that offer a paper trading feature. Thinkorswim by TD Ameritrade is one of them. You have to set up a brokerage account to get access to it, but it’s free. A lot of our video tutorials will feature that platform, too.

Another option is you could use very small position sizing (such as one share for each trade) until you get comfortable or want to increase your position size.