Paper trading, commonly known as demo trading, is an important part of any trader’s journey. It refers to the process of trading in the real market without using real money.
A demo account is useful for both new traders with little experience and also for professional traders. Whether it is testing a new strategy or refining one that is already working.
In this article, we will explain the best process to move from paper trading to live trading.
What is paper trading?
Trading is a high risk activity to do. Indeed, most people who start trading don’t make it in the long run. As such, it is useful for one to get real training about the market without risking their own capital.
To deal with this situation, online brokers usually provide their traders with a demo account. In demo mode, these traders have full access to the real market without risking their capital.
As a result, they can experience the market situation well and see whether it is the right thing for them. For example, a trader who succeeds in a demo account has a higher chance of being successful in the real world.
Still, paper trading is not confined to inexperienced traders. In most cases, many successful traders use a demo account regularly. They use it when they are testing a new trading strategy.
For example, a trader who uses scalping technique, can use a demo account to test a new approach such as pairs trading.
Pros of the demo mode
There are many advantages of trading in a demo mode. First, it allows traders to test drive the market and determine whether it is the right thing for them. In most cases, many people end their new trading careers in their demo account after seeing how difficult the market is.
Test new strategies with real data
Second, a demo account is a good place for both experienced and inexperienced people to test their strategies. This is important because of the risks involved in testing a new strategy in a live account where you can easily lose all your capital.
Third, a demo account has everything that is found in a real account. Therefore, people who use these accounts experience everything that real traders go through in the market.
Fourth, paper trading is a good place to backtest and forward-test an automated strategy. An automated strategy refers to a robot that automatically analyzes and executes trades.
These bots are very popular these days. A demo account will give you an opportunity to backtest the strategy without putting your money at risk.
Finally, a paper trading account can help you grow your confidence in the market. If you are worried about losing your real cash, a demo account will help you boost your confidence as you transition.
And if you have suffered a bad loss and are afraid of making a mistake again, the testing platform will allow you to regain your confidence (or convince you to take a little break)
Cons of paper trading
Paper trading has many benefits and is recommended for all people who are interested in the market. However, it has several disadvantages that you should be aware about. Let’s go over some of the most dangerous cons of using a demo account.
First, many people have a different feeling when they lose money in a demo account vs in a real account.
In most cases, they don’t feel the emotional challenge when they lose money in a demo account simply because they can open a new one instantly. Also, in paper trading, they don’t lose any money.
Second, while paper trading is exactly similar to using a real account, the reality is that the two situations usually feel different.
In paper trading, you are risking nothing while in a real account, your cash is at stake for all trades that you execute. Therefore, many people tend to fill different when using the two accounts.
Third, a demo account does not have some things in consideration. For example, it does not put the broker commissions in focus.
Finally, when paper trading is not done right, it can send the wrong message to a trader. For example, it is often to see a new trader make a lot of money in paper trading and then assume that they are now professional traders.
As a result, they move to a real account and lose their money within a short period. This is a cognitive bias known as overconfidence, and it can afflict anyone. Even pro traders.
How to move from paper trading to a live account
At Day Trade the World (DTTW™), we have an advanced account where one can test their skills without risking real money. In our experience, some traders are able to transition from a demo to a real account smoothly.
Make it like real trading
First, you need to ensure that you take demo trading seriously. In other words, take it in a similar way to how you take a real account. By so doing, you will experience the same feeling as with the live account. It will also help you trade well.
Journaling your tests
Second, always use a trading journal when using a demo account. A journal is a document where you write down all your trades. It involves sections like the asset, the opening and closing price, why you opened it, and the profit or loss.
The benefit of journalizing all your trades is that it will help you learn from the process.
Don’t be in a hurry to go live
Third, you should ensure that you have actively spent time in a demo account befor you move to a live account.
Many people make this transition within less than a week. This is wrong. Instead, it is recommended that you spend at least three months (or six) in a demo account.
Finally, start your live trading journey slowly. Now that you have gained experience in demo trading, do everything conservatively.
For example, if your goal is to trade with $10,000, start with $5,000. Also, use a small amount of leverage and positions. You should then increase these numbers as you grow.
In this article, we have looked at the concept of paper trading, why it is important, and some of the most important strategies to use when using it. Most importantly, we have explained how to transition from a demo account to a live one.
External useful resources
- How long should I paper trade before jumping into options with real money? – Quora