By Larry Wright
Introduction
Investing is very rewarding in terms of financial benefits. However, it is not as easy as it may appear at first glance. The investors who are getting started and those who have years of experience are almost equally susceptible to unwarranted changes in the financial markets.
However, investing techniques have been improving and changing for hundreds of years. Therefore, investors have come up with a technique to make projections and run calculations without putting their capital in danger. This article is going to discuss Paper Trading and how it is a necessary arsenal for every investor.
What is Paper Trading?
Paper Trading is the method of performing a trade based on an already finalized trading strategy without putting the actual investment fund in jeopardy. One of the biggest fears for an investor is to lose their capital despite planning and to deliberate over their trading scheme.
Therefore, Paper Trading is a technique that allows investors to pan out their trading projections in theory before carrying out the practical trade. Paper Trade can seem like a fairly recent phenomenon. However, the technique has been around before the digital trading tools and apparatus at the disposal of traders and brokers.
Origin of Paper Trading
The formal founder or originator of paper trading is not known. However, Paper Trading dates back to the time when professional investors would spend hours or days at the end to pen down the results of all their prospective trading strategies on paper.
Today, Paper trading looks very different from its initial form. Modern traders hardly soil any real papers to pen down their trading strategies. With the introduction of stock market simulators, artificial intelligence, and other trading algorithms, investors can perform paper trading in an instant.
Readers who are interested in learning more about Paper Trading can get some help from a famous book called ‘The Truth About Day Trading Stocks’ by Josh DiPietro, who has dedicated Chapter#18 to discuss the dynamics of paper trading for investors.
How does Paper Trading Work?
The idea behind Paper trading is to use a digital simulator or a paper to jot down the calculations that allow the investors to make money. In this manner, the investors would be able to foresee any flaws in their plan and pick out the trading strategy that pays out the maximum profits for them.
At the same time, the investors can also account for all the possible loss-inducing factors in their trading strategy to find out how much it will impact their profitability. Paper trading in the past was all about spending a lot of time making projections.
However, with the help of the latest digital tools, investors can perform paper trading with rapid speed and make sure that they can get the best results out of their ventures. In hindsight, Paper Trading is a way to perform real trade with fake money or without taking any real trading risk.
Types of Paper Trading
There are two rudimentary types of Paper Trading classifications that investors can pick from depending on their preferences.
Financial Simulators
Financial Simulators are programs that allow investors to create a unique portfolio based on real stock entries. However, for the sake of investing, the users can input fake or digital money that does not hold any real value.
Therefore, investors can input their trading strategy into the system and run simulations to see the results. These financial simulators insert a deliberate 20-15 minute pause between running two or more simulations to make sure that the investors are not entering into real trading positions.
Some financial simulators can run trading strategies based on random data input. Such a randomized system is created to find the best possible combination for trading by elimination process.
Fantasy Simulators
Fantasy Simulators are options for traders who want to run a test beforehand before starting a real-world virtual simulation. However, Fantasy simulators do not contain stocks, commodities, or other investment options.
Consumers are mostly using trading products that are not part of the real world, and in this manner, they can gain some insight into the trading market. The products that are listed on this type of simulator are books, movies, TV series, and other objects that are not usually listed on the stock or commodities exchanges.
Key Features of Paper Trading
The main components that compose Paper Trading as mentioned as under for the benefit of the readers:
Intent to Trade
The first and foremost component of Paper Trading is the intent of trading. Many people around the world are stuck in a vicious cycle of 9-5 jobs. People around the world are growing weary of the job culture with every passing day. The idea of working for oneself has started to give rise to the ideologies such as the gig economy.
At the same time, continuous money devaluation and rising inflation are enticing people to amass wealth so that they can enjoy the necessities of life, such as healthy food, education, transport, medical care, home, etc.
At the same time, most people are unable to have enough capital for investing. With a limited amount of capital, the idea of entering into the bullpen and risking it all can is understandably frightening. Therefore, Paper Trading is a way to go that can help investors to gain more confidence and, at the same time, keep their intent to invest intact for longer.
Practice
Practice makes perfect, and the same is the case with investing and trading. Most traders refrain from entering the arena because they lack proper education and formal training. Just like many other skills in life, the best way to learn to trade is to just get started.
However, without a massive amount of investment capital, not every trader can take the risk of getting slammed in the trading markets. This is where Paper Trading can be useful and grant the investors a chance to hone their skills.
There is no stress of losing money, and after a risk-free training session, investors can overcome their fear of the market and start using trading options.
Virtual Simulators
Before the advancement of technology, most investors performed paper trading on actual papers. However, luckily with the help of virtual simulators, investors can perform paper trading runs in a matter of days that could take weeks or months on paper.
At the same time, virtual simulators also have lesser chances of making errors in calculations which can greatly increase productivity for the investors.
Today, it is almost impossible to imagine the paper trading process without the presence of a virtual simulator or digital trade training environment.
Programming
Programmers often dabble in the virtual trading market out of sheer curiosity. The most popular languages for Paper trading programs are C#, PHP, JavaScript, Java, MySQL, PostgreSQL, C, and other databases.
The developers who wish to test their machine learning and artificial intelligence skills may put together a basic analytical program that they can keep improving over time. Therefore, programmers are considered an important prerequisite for paper trading.
Games about Investing
The best way to get started with investing is to learn it through games. In this manner, the process is not hefty, and it does not put pressure on participants to succeed in their trades.
Sometimes, investors can perform paper trading by enjoying investment games such as monopoly and others. Some blockchain platforms, such as Axie Infinity, also help investors to learn the dynamics of cryptocurrency trading while enjoying a gaming interface.
Investors who wish to take their investing lessons one step further can dabble in investing books to sharpen their paper trading strategies.
Advantages of Paper Trading
Here are some compelling reasons that are seen as the defining components for the commencement of paper trading.
Investing Education
Investing is a very important aspect of the human career. However, most academic institutions in the world do not teach students anything about the importance of managing their finances. Therefore, most investors only get started in their adult years. As a result, they are still reluctant to step into unchartered territory.
Therefore, using a financial simulator can take away the risk of real losses, and the investors can keep learning to trade and gain experience. Furthermore, these virtual simulators can also work as a great learning and educational program for investors who are still in the process of implanting their feet into the trading world.
Building a Portfolio
Most retail investors are uninitiated in the process of creating a new trading portfolio. Therefore, using a virtual simulator can help the investor to understand the art and science of creating a new trading portfolio.
The investors can try out different recipes for creating new portfolios, and they would not have to lose their investment capital. At the same time, the traders can pick and eliminate different portfolios to use in real-world situations.
Investment Strategies
There are many successful investors in the world, and no one can provide a failsafe investment strategy to the investors.
Therefore, investors can learn from the experts about different market dynamics, but at the end of the day, they need to have a reasonable understanding of how different trading stimulants impact the marketplace.
Virtual simulators allow investors to implement different trading strategies under the pretext of different market variables on the same trading portfolio. The comparative analysis and perfecting the lags can help the investors formulate solid investment strategies that have good chances of generating profits for them.
Logical Thinking
Most investors would like to think that they are not swayed by their emotions when trading. However, the influence of mass media and social platforms on people is stronger than they can imagine.
Therefore, investors are prone to make errors of judgment if they get caught up in market speculation. Using virtual financial simulators is a great way to eliminate emotional decision-making and train the mind to make all trading decisions based on facts and technical analysis.
Limitations of Paper Trading
Market Correlation
During periods of high market correlation, stocks and other trade commodities can start to move in a codependent manner. High market correlations period are indicated by the market rising Market Volatility Index or MVI.
Therefore, paper traders can miss the market boom sections because a simulation is going to project bad results for the consumers. As a consequence, the investors are unable to gauge the dynamics surrounding singular security or stock.
Commissions and Lapses
When investors are present in the real world, they have to deal with all types of sudden costs, such as transaction costs and commission fees, etc. However, when using virtual simulators for Paper Trading, the traders can exist in ideal scenarios that exempt them from any sudden unfavorable market changes, such as an increase in taxes, etc.
Another major downside for an investor with paper trading is that it does not account for slippage and does not portray the imperfection of the real-world trading environment. One example of this is that while paper trading, investors would only account for the spot price of an asset.
However, in the real world, the investors would have to account for all the hidden costs associated with their first purchase, like the transaction fees, taxes, forex exchange, and others.
Gratification and Fear
When investors are performing trades in the real world, they have to face the real danger of sustaining losses. The fear also motivates them to put their best foot forward when making decisions.
However, with Paper Trading, all the losses are only going to happen on a mere paper. Therefore, the investors are bound to be as motivated as in real-life trading. Even if the traders can devise the winning strategy, they won’t experience the same sense of gratification that comes from earning profits in the real world with real money.
Inflexibility
The strategies that are created and perfected using paper trading techniques are rigid and inflexible. They usually cannot make adjustments for the unseen market changes that can occur at any moment.
Therefore, when investors try to implement the formfitting paper trading strategy in the real-world market, they can feel trapped. The real market is not going to be as smooth and predictable as paper trading.
Paper Trading vs. Crypto Trading
When it comes to cryptocurrency trading and paper trading, the practice can be termed as an effective trading technique that posits both pros and cons. Therefore, the investors should account for both sides of the coin:
Positives and Similarities
Most virtual simulators can entertain real-time data from on-chain sources. Therefore, paper trading for cryptocurrencies is ideal and realistic to the original market trading. At the same time, there is a massive variety of cryptocurrency variants; therefore, investors cannot dive into the market without having any pretext or prior knowledge.
The paper trading technique is ideal for cryptocurrency investors because it saves time and energy for investors. At the same time, it also grants investors a way to perform error-free analysis and apply it to every singular cryptocurrency without manual implementation.
Negatives and Differences
The negative implication of using paper trading for cryptocurrency trading is that the investors can get lost in translation. Several minor factors in the DeFi market are not well-defined; therefore, developers can find it difficult to quantify these factors effectively that are resulted from changes in political clarity or change in legislative infrastructure.
At the same time, even when a virtual currency is great in terms of price performance, it might not remain around on account of technical errors or exploits. Such situations are not under the purview of paper trading.
Therefore, cryptocurrency investors cannot solely depend on paper trading to devise the perfect investment strategy for crypto trades.
Conclusion
Paper Trading is not a perfect solution to all the problems of a trader. The investors can, however, improve their chances of earning profits, managing risks, and downsizing losses by a huge factor.
Therefore, in all fields of investing, including cryptocurrencies, investors can implement their experiences from paper trading.
At the same time, investors must keep in view the limitations of paper trading and take steps to counter these disadvantages. The investors are not in the market to compete against each other.
On the contrary, the main goal of an investor is to find the best and simplest way to maximize their profits. Paper Trading is therefore endorsed by both professional and amateur investors as a way to advance their investing skills.