4 Reasons to Try Paper Trading

With trading, as with most endeavors, perfection is almost never the goal. Instead, you should aim to consistently refine your skills. One practice traders often use is paper trading, a form of simulated trading where only imaginary money is at stake.

The term "paper trading" harks back to a time before computers, when aspiring traders practiced their trades on paper before risking money in live markets. These days, it's much more sophisticated thanks to online tools that replicate the live trading experience (see "Paper trading at Schwab").

Here are four situations where you might consider simulated trading before putting actual dollars in play.

I've found the most effective way to learn is by doing, but learning often means making mistakes, which can be a deterrent to trading when real money is at stake. With paper trading, newcomers can dip their toes into the markets and start to test strategies without the threat of losses.

Even more seasoned traders may benefit from a virtual experience. Maybe you're a fundamental trader who wants to dabble in technical charts, or vice versa. Or you have substantial experience trading stocks with strong momentum but want to hone your defensive skills in case the market takes a turn. Or perhaps you learned about a new trading approach via Schwab's YouTube tutorials and want to try it out for yourself. Whatever the case may be, paper trading can help traders grow and refine their trading skill set.

Sometimes a losing streak can seem hard to break. Paper trading lets you tweak your approach through virtual trial and error, which may help you reenter the market with more confidence.

That said, be mindful of the emotional differences between live and simulated trading. Maybe your slump was exacerbated in the heat of the moment, which can cause us to act in ways counter to our goals. While paper trading can't truly replicate the intensity of having real money on the line, the more you practice, the greater your ability to manage knee-jerk reactions in actual high-stakes situations. It can also help you develop emotional discipline by exposing you to certain market situations where you can gain experience without the risk.

Anytime you're learning a new trading platform—which many clients are, given the recent rollout of the award-winning thinkorswim^® platform—paper trading can help you learn its key functions so you're not scrambling to navigate a new tool when you're in the thick of the action.

Whatever your motivation for trading in a simulated environment, here are a couple of considerations:

• Treat it like the real thing: If you want to get the most out of paper trading, it's important to give it your full attention. Follow your trading plan just as you would with a real trade: Do your due diligence, set your usual entry and exit points, monitor your positions, and don't take on more risk than you normally would just because it's "play" money. The goal of practice is to help you improve, but any bad habits you pick up could sneak into your real trading experience—and potentially risk your portfolio.
• Scrutinize performance: One way you can improve your craft is by understanding the cause of successes and failures. A good streak or a series of losses may be traced back to a deliberate change in behavior. You may want to focus on racking up some wins and having a strong gain/loss ratio in the paper environment before trading a new strategy or method with real money.

Although perfection is an illusion—at least when it comes to trading—practice is key to improving your techniques. If you exercise paper trading with a real commitment to learning, I think you could find plenty of value from the effort.