Financial markets are fast-paced with opportunities ripe for both wins and losses. If you are new to trading or are looking to sharpen your skills, you might consider whether to trade using paper money or live trading.
Live trading puts your money where your mouth is and your wallet on the line. Paper trading helps you understand your own emotions and test new trading strategies. Here are a few considerations about paper money versus live trading before you start trading securities on your platform of choice.
What Is Paper Trading?
Paper trading is the act of using virtual money to buy and sell securities. Virtual money is not real, but it gives you an idea of how your trading strategy might have worked out. The aim of paper trading is to simulate trading in a live market without using your own funds.
Who Should Paper Trade?
Paper trading serves multiple purposes, which makes it good for experienced and new traders. If you are an experienced trader and want to test a new trading strategy, paper trading is a good way to gauge its effectiveness.
If you are new to trading, it is advisable to start with paper trading before committing to real money. This can help you obtain a grasp of how trading securities work in a live market.
Technical Considerations
With paper trading, the broker provides a demo account that mimics price action in the live market and allows you to place trades with virtual money (demo trading). But you won’t experience any actual market conditions related to live trading execution.
Psychological Aspects
Paper trading gives you a sense of confidence to take on more risks without fearing potential losses because you are not using real money. You may also act differently in a simulated market environment
Advantages of Paper Trading
Paper trading offers several advantages for investors and traders. Let's take a look.
- Practice: Paper trading allows you to gain experience in every element of the trading process, from timing the market to taking a profit or cutting your losses.
- Test new strategies: Checking out trading ideas is useful not only for beginners but for experienced traders as well. This account type allows for testing your tactics on the asset history
- Confidence: Paper trading can help you to build some confidence to trade in a live market.
Disadvantages of Paper Trading
Despite its benefits, paper trading does have a few shortcomings that should be considered. Here are some of them.
- Not real: One disadvantage of paper trading is that it's not real. A trader can't keep the returns from paper trading.
- Limits the impact of emotions: Another shortcoming of paper trading is that it tends to limit the impact of emotions because real money is not in play.
- Extra costs are not accounted for: Omitting the impact of commissions and slippage on a trader's profit is another flaw of paper trading. Slippage is the difference between the price of a security at the time the trader decides to buy or sell and the price they receive for it. Brokerages also charge commissions for any trade executed on their platforms. These two factors are a reality in live trading but absent in paper trading.
Example of Paper Trading
When you demo trade or use a stock simulator to place trades on a trading platform with virtual money (paper money), you are paper trading.
What Is Live Trading?
Live trading means actual trading using a brokerage account, where investors buy and sell securities with real money and take real financial risks.
Who Should Do Live Trade?
It is advisable to try your hand at paper trading before live trading. If you are a newbie, you can begin live trading with smaller amounts before increasing your stake.
Technical Considerations
When live trading, there are several factors to consider. First, you have to understand how commissions and slippage impact your profits. Commissions are known beforehand and can be factored into the trade. Slippage, which is the difference between the expected price of a trade and the fill price, cannot be known beforehand as it depends on how fast the order is executed.
Psychological Aspects
Because real money is involved in live trading, it is easy to be overwhelmed by emotions. Rapid decisions led by emotion may lead to losses.
Advantages of Live Trading
There are several advantages of live trading that make it a preferred method for many traders. Some of the advantages are the following.
- Live results: Live trading is a real scenario, which means you get to observe the impact of broader market conditions on the price action of securities and by extension the viability of your trading strategy.
- Actual market conditions: A live trading experience also allows you to understand factors such as capital and risk management, understanding the impact of market execution on your trade, tax-loss harvesting or how to control your emotions, which are crucial in developing a successful trading approach.
- Potential returns: Because you are trading with real money, gains earned from live trading are real and yours to keep.
Disadvantages of Live Trading
While there are numerous benefits to live trading, it is important to consider the potential disadvantages as well. These are the following disadvantages.
- Can incur losses: You can incur real losses through bad trades, reacting emotionally to market volatility, poor timing of trades or not conducting appropriate fundamental or technical analysis.
- You may get emotional: Because real money is involved, trading could trigger emotions that might undermine a logical approach to your trading using technical or fundamental factors.
Example of Live Trading
When you open a live account with a brokerage and start trading with real money, you are live trading.
No Substitute for Live Trading
Lessons learned from paper trading can be invaluable, but it is not exactly the same as live trading. You can test trading strategies and get your feet wet in a simulation environment, with low stakes and virtually no downside (aside from the time spent). But a live trading environment may also produce different conditions related to trade execution risk or emotional differences. Even so, both environments can be useful for traders, new or experienced.
Frequently Asked Questions
Is paper trading easier than real trading?
Paper trading is easier than live trading because there is no risk involved.
Is paper trading good for beginners?
Paper trading is good for beginners because it gives them a chance to develop a trading strategy learn from their mistakes and understand the market
Is paper trading more worth it than live trading?
Paper trading is useful, but the experience can’t be compared to what you gain from live trading.
About Anna Yen
Anna Yen, CFA is an investment writer with over two decades of professional finance and writing experience in roles within JPMorgan and UBS derivatives, asset management, crypto, and Family Money Map. She specializes in writing about investment topics ranging from traditional asset classes and derivatives to alternatives like cryptocurrency and real estate. Her work has been published on sites like Quicken and the crypto exchange Bybit.