Jumping into the forex market can feel like being asked to fly a commercial jet without any training. The market is hyperactive, the commodities go in multiple directions, and the entire process of understanding and using the market can be extremely overwhelming. Fortunately just like with commercial pilots there are training simulations available for trading too.
With the forex market, one way to gain experience is with paper trading, also known as simulated trading or a demo account.
Video: What is Paper Trading
What is Paper Trading?
A paper trade refers to simulated trading exercises where new investors can practice buying and selling currencies without actual money being involved. Think of it like learning how to play poker and using cookies for betting chips.
While a paper trade can be done by simply keeping track of hypothetical trading positions, these simulations usually involve the use of trading software that will provide all the real time trading data of real live account. To put it simply, paper trading lets an investor use the full range of trading facilities in a simulated environment using real market conditions.
Aside from being a tool that can break new investors into the experience of trading on the forex market, a paper trade can also be used by more experienced investors to test a new investment strategy before transferring it to a live account. Think of it like test marketing a new product.
Whether as a training tool or simulation exercise, investors engaging the paper trade have to be able to make decisions based on the same risk-return objectives, investment constraints, and trading horizon as if it was a live account. Paper trading should not be treated as a game simulator where an investor does their best to rack up a high score.
Benefits of Paper Trading
As with any market, investors using a paper trade need to familiarize themselves with trading. When placing a paper trade, investors and traders should familiarize themselves with various order types before engaging the paper trade. Placing a paper trade should be done under various market conditions, just like a real market.
Doing this allows the new investor to have a better understanding of the trade experienced from a simulation and an experienced investor to better judge the effectiveness of a given trade strategy.
Novice investors should also note that paper trading might give them a false sense of security regarding their trade abilities, particularly regarding their investment returns. In terms of actual trade experience, paper trades cannot accurately relay the experience of the market the same way true trading does, as paper trading does not involve risking genuine capital.
As a result, basic investment strategies that can be difficult to follow in real life can appear relatively easy to achieve while paper trading.
While paper trading can be a great educational tool for investors, a person will never truly know how they will react to a given situation until they actually find themselves in that situation.
Learning to trade forex solely through paper trading can be like learning to swim out of the water; sooner or later, you’ll actually have to jump in the water to find out if you’re any good at it.