- By paper trading before making an actual investment, a beginning investor can get familiar with the way the market works and can practice buying and selling without having real money on the line. Most investors begin paper trading by watching a stock they are familiar with and pretending to "buy" at a price they see posted in the daily newspaper. Today, however, there are several excellent online stock trading simulators to hone trading skills.
- Paper trading will tell an investor whether or not he is on the right track with a given strategy. By pointing out problem areas, a stock trading simulation helps to control the downside risk from trading errors when an investor "goes live" and begins trading with real money. Some of the more sophisticated online stock trading simulations allow for futures and trading on margin as well. Many even offer paper trading "contests" with real money prizes.
- While paper trading can be both fun and a useful investing tool, it is important to limit the length of time an investor paper trades. Often investors will use paper trading as an excuse to delay a real investment, and it is possible to suffer from "paralysis by analysis." It's important to remember that the purpose of paper trading is to make an investor more effective in the real world of actual trading.
- With skills honed by weeks or even months of dedicated paper trading, an investor is better prepared to enter the market and take advantage of the price movements that are now easily recognizable to him. If an investor uses a disciplined approach to paper trading, it is likely he will achieve profitability in the market much sooner than a novice investor would.
- It is absolutely critical for an investor to be totally honest with himself about his paper trading results. Even with an online stock trading simulation that is as realistic as trading the market itself, the temptation exists to take unrealistic risks in order to offset paper losses and make the portfolio look better. Bad habits developed during paper trading will follow an investor into the real market and will mean substantial losses if the investor ignores a disciplined approach to trading.
