Can Paper Trading Offer Accurate Results?

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Contributor, Benzinga
October 15, 2023

Remember the training wheels you had on your bike? On the one hand, they made learning to ride on your own easier. But on the other hand, they could never replicate the experience of riding without them.

Paper trading works the same way. It provides a demo mode during which you can practice real-world trades.

Is paper trading free? Yes, in the sense that it provides practice without risking actual dollars. But does it actually offer results that reflect the real-world market? This article explores that question.

The best way to learn about stocks and investing is through an investment platform. The right tools can help you research and monitor every investment to help maximize every dollar.

Is Paper Trading Accurate?

A paper trading platform offers simulated conditions designed to help investors learn the basics of the market and sharpen their trading skills. But while these tools are designed to reproduce the conditions of the market, paper trades are rarely fully accurate.

Reasons Paper Trading May Be Less than Accurate

A stock market simulator can be a valuable tool, especially for beginners. But paper trading doesn’t provide the accuracy of the real-world market. Why not?

1. View of the Stock Market Can Be Unrealistic

Even the most advanced paper trading platform can’t replicate the actual conditions of the stock market. For instance, demo platforms can’t accurately portray the relationship between broad market conditions on individual stock prices, which can give investors a false impression of market volatility.  

2. Simulated Fill Prices May Not Accurately Reflect Real-World Conditions

A stock simulator can’t always account for industry trends or economic realities that alter the price of individual stocks. As a result, investors may be practicing with prices that don’t correspond to the behavior of their real-life counterparts.

3. Emotions Associated with Live Trading Are Not Involved

Is paper trading free? Yes — and that’s often its greatest shortcoming.

Even the military uses live ammunition when training for combat. When investors have no skin in the game, a simulated environment won’t develop the same discipline that comes when actual dollars are at stake.

4. True Cost of Trading Is Not Simulated

Paper trades rarely capture the hidden costs of slippage and commissions.

Slippage is the difference between the expected price of a trade and the actual price when the trade is executed. And depending on your brokerage account, you could face commissions and other trading fees that drive up the cost of each trade.

Strategies to Make Paper Trading as Accurate as Possible

Despite these shortcomings, paper trading is a valuable way to hone your trading strategies. Here’s how to improve the accuracy of your paper trades.

1. Simulate the Real Market

Start by finding a paper trading account that offers the same features and functions as a real trading account. Look for simulators that duplicate the market volatility index (VIX) or monitor industry trends.

2. Be Disciplined When Paper Trading

In the back of your mind, you’ll always be aware that a paper trade isn’t the real thing. But for now, try to pretend that it is. Keep a journal of your trades and their results, and remind yourself that soon these numbers will apply to your actual money.

3. Use More Up-to-Date and Accurate Data

Never use a stock market simulator that isn’t regularly updated with accurate, real-world data. That way, when you transition to a standard trading account, you’ll be dealing with the kinds of conditions you’ve prepared for.

4. Pay Attention to the Fees Associated with Every Trade

Your brokerage account comes with trading commissions and maintenance fees that will influence every trade. Make sure you account for these fees when making your trades so you’ll know what to expect once you start trading.

5. Keep a Detailed Record of Your Paper Trading Results

Keeping a record of your paper trades can help you track your progress and discover which trading strategies work best for your goals.

How to Measure the Accuracy of Your Paper Trading

How do you know how accurate paper trading methods are? Here are a few basic tips.

1. Understand the Concept of Risk-Adjusted Return

This method measures performance relative to the amount of risk taken. That means you’ll need to weigh the risks associated with your trades against the amount you’re getting back.

Keep in mind that you may be more risk-averse in the real world than in the simulated world of paper trades. As such, you’ll want to develop discipline as you learn the ropes of trading.

2. Compare the Performance of Your Portfolio and Other Portfolios in the Same Asset Class

You can also gauge your accuracy by comparing your portfolio to others in the same asset classes. Many brokerage platforms offer community features that let you compare notes with other investors, allowing you to discover new investing strategies and check your progress against other industry-specific benchmarks.

The Enduring Value of Paper Trades

Is paper trading free? Your brokerage account may charge a fee to maintain membership, but once you’re using the platform, all your trades will take place with simulated dollars.

Stock market simulators will always play a role in helping investors sharpen their trading skills. In fact, novice traders should begin their journey with a paper trading platform before making their way to real-world trades.

While they don’t deliver spotless accuracy, users can still find ways to employ these tools to simulate real-world conditions and become better investors.

Frequently Asked Questions

Q

How similar is paper trading to real trading?

A

The realism element can be hard to quantify, but the best paper trading platforms will attempt to simulate actual market conditions using up-to-date information and include all the features of a traditional trading account.

Q

Is paper trading smart?

A

Getting your start with paper trading is a wise strategy. Beginning investors should aim to spend six months or more performing paper trades before graduating to a real trading account. Even seasoned investors can use paper trades to sharpen their skills and test new strategies.

Q

What are the benefits of paper trading?

A

Paper trading allows you to experiment with different trading strategies without risking actual money, which lets you quickly learn new skills and become a better investor.

About Sarah Edwards

Sarah Edwards is a finance writer passionate about helping people learn more about what’s needed to achieve their financial goals. She has nearly a decade of writing experience focused on budgeting, investment strategies, retirement and industry trends. Her work has been published on NerdWallet and FinImpact.