How to Paper Trade Stocks in 9 Steps

What if stock losses didn’t matter? You could take a loss, reset your portfolio with the same capital as you had when you started and try again. While this sounds like a fantasy, it’s something you can do with paper stock trading. Stock simulators let traders use imaginary money to simulate buying and selling stocks. Gains and losses can be reset with the click of a button. While the reset feature sounds nice, why would people consider paper trading even though it has no impact on their wealth? This guide will detail some of the reasons people use paper trades and how this approach can potentially help you when real money is involved.

What Is Paper Trading?

Paper trading is just like stock trading in the active market. You simulate buying and selling stocks in real time and monitor your demo portfolio’s performance. However, paper trading lets you play with imaginary money instead of using real money from your bank account or portfolio. You can decide on your portfolio’s size and invest accordingly.

9 Steps to Start Paper Trading Stocks

Paper trading creates a zero-risk environment for traders and investors seeking to learn about stock market basics, test themselves during volatility and become confident in an investment strategy. You can follow these steps to set up paper trading for your own use.

1. Learn the Basics of Stock Trading

You won’t get punished if you go into paper trading with zero knowledge. While experience is the best teacher, traders are guessing if they go into paper trading without any knowledge. An investment approach that relies on guessing isn’t reliable in the real market. You should look at technical indicators, fundamental analysis and other core concepts before getting into paper trading. You should continue learning about the stock market as you paper trade. An investor’s learning never stops.

2. Prepare Your Trading Strategy

The way you prepare for your paper trading strategy will resemble the work ethic you use for a stock trading strategy. If you do not take your paper trading strategy seriously, it may show in an unfavorable way if you transition to trading with real money. Traders should review multiple investment strategies and come up with an approach that works for them. Listing entry and exit prices for each stock you are looking at may potentially help you make profitable trades.

3. Choose a Stock Market Simulator

A good stock market simulator lets you paper or  demo trade stocks in real-time with imaginary money. These simulators may also provide easy access to news articles and educational resources for traders. Some simulators have more features, but having those basics will put you on the right track.

4. Sign Up with Your Chosen Online Broker

After shopping around, consider signing up with an online broker that offers paper trading. You should feel confident in the broker you select, and reviewing several choices can make you feel more comfortable with the broker you select. Many online brokers that offer paper trading also provide the ability to sign up for a brokerage account where you can trade with real money, but you shouldn’t use real money right away.

5. Start Paper Trading

You’ve done your planning, looked at several brokers and decided on the right one for you. Now is the time to start paper trading and put your ideas to the test. When paper trading, you don’t have to worry about losing money, but pay attention to how you feel throughout the process.

6. Analyze Your Performance

Your demo portfolio’s performance reveals the validity of your trading strategy at that moment. Some investors have a long-term approach and may get tied up with an unfavorable market. You can compare your performance with a popular benchmark like the S&P 500 or NASDAQ Composite 100 to see how well your portfolio is doing. Write notes about how you feel about each trading day so you can refer back to them. 

Reflecting on your trades and analyzing your performance can help you avoid making significant mistakes with real money. No investor is perfect, but reviewing your portfolio can increase the probability of making profitable trades.

7. Be Realistic and Adjust Your Expectations

As you paper trade more often, you will get a better understanding of which types of returns are realistic and which ones are a stretch. You will also get a better idea of the type of risk involved in generating returns. Traders generally don’t incur as much risk if they want a 5% annual return compared to wanting a 50% annual return. But wanting something doesn’t guarantee it will happen, especially if you strive for a higher return.

You can adjust your expectations periodically based on your portfolio’s performance and how your risk tolerance changes over time. Some traders initially use riskier strategies in pursuit of a 50% return, only to end up with a greater loss instead. A trader in this position may go for a more conservative approach and seek to string together smaller returns that may compound over time.

8. Keep Practicing

Continuing to practice helps you learn more about the stock market and what works for your portfolio. The beauty of using paper money is that you can practice as much as you desire without any financial consequences. Traders can develop a good mindset and know which investments may complement or abandon that mindset. It’s great to make mistakes with paper trading because you get to learn what those mistakes are and adjust your response to those mistakes before using real money.

9. Consider Live Trading Once Ready

After getting more experience with paper trading and learning about the stock market, it may be time to consider testing your trading skills with real money. While stock simulators can be fun and provide no risk, you don’t get to benefit from the potential growth of real money. Though, you are exposed to potential losses as well. You have to use real money to achieve goals for your retirement portfolio. 

An Example of Paper Trading Stocks

A trader is looking at a stock that currently trades at $100 per share. This trader wants to buy the stock at this price point and exit when the stock hits $102 per share. However, the trader still doesn’t have the most experience and feels nervous about making the trade. Paper trading removes the anxiety factor by eliminating portfolio risk. The trader can confidently simulate buying shares at $100 apiece to see what will happen. If the stock goes up to $102 per share, the trader will then sell at an imaginery profit of $2 per share.

Is Paper Trading Worth It?

Paper trading has many benefits for investors who are getting started. You can test your strategies and see how you respond to market uncertainty before real money is involved. Beginner mistakes aren’t costly and can prepare you for a portfolio with real money. Seasoned investors can continue using paper trades when they want to test out new investment strategies, such as options trading. If you have no experience with a certain strategy or type of asset, paper trading can help you build experience without resulting in significant losses. 

Things to Consider

Paper trading has many benefits and a few disadvantages. The primary disadvantages are the amount of time it takes up and the risk of fear of missing out (FOMO). Paper trading can take up hours of your time each day if you aren’t careful, and it won’t lead to any returns because the money is imaginary. 

Another risk is that the stock you buy immediately surges 50% on your paper portfolio. While this may sound like a good thing, this surge can tempt you to use real money too early and buy into a position because of FOMO and how it did in your paper portfolio. Rushing to buy a stock with real money because of what happens in your paper portfolio can translate into losses in your real portfolio. If you keep your emotions in check and don’t rush to use real money based on what happens in your paper portfolio, you may not run into this issue.

Paper Trading Your Way to More Competence

Paper trading can help you learn the ropes and understand how the stock market works. This approach teaches you how to deal with gains and losses. Greed and fear can dictate any investor’s actions, and journaling about your experience helps you learn more about yourself as a trader.

Frequently Asked Questions