What is it?

Most of you have probably heard the term “paper trading”, but what exactly is paper trading? It’s simply the process of mock trading, or tracking trades and calculating profits and losses as if you were trading with real money. You could paper trade anything but we’re going to focus on commodity futures contracts and futures options.

Why do it, what are the benefits?

It's Free -- All you need is paper and pencil and quotes & charts from a newspaper or your broker.

It's Easy -- Access charts and daily price quotes and enter your paper trades in a Paper Trading Log. Better yet, use an online service such as PAPERTRADER® Online.

It's Risk Free -- Considering you are not risking any real money, you can’t lose. Make your mistakes on paper BEFORE risking real money

Familiarity -- Learn the characteristics of the various markets, how to calculate profits/losses, how margins work, and what to expect BEFORE your money is on the line

Flexibility -- You aren’t limited to just a few markets, you can “trade” many markets, try new strategies and learn from past mistakes

Learn by Doing -- There is no better way to learn something than to immerse yourself in it

It's Quick -- Only takes minutes per day once your routine is figured out

How to Pick Your Trades

In the past paper traders updated outdated charts by hand, a painfully tedious chore that would take hours. Updating charts by hand is no longer necessary as you can view current charts for free on the Internet. Use technical analysis and/or fundamentals to determine the markets that you want to paper trade and the positions you’d like to take. For instance, if you had studied Corn fundamentals or saw a chart formation that signaled to you March Corn might be dropping in the near future you could paper trade a short position in corn.

Since there is no actual money involved, just for fun you might also consider paper trading as many markets as possible with no regard for margin requirements.This would provide you with exposure to all the sectors and markets. You might also trade a paper trading account in the exact same manner you plan on trading your real account, which means starting with the same balance and not over-leveraging the account by being in too many trades simultaneously.

How to Track Your Trades

Assume that March Corn settled at $2.28 and you’d like to know how a short position would do from that price. You could mark that position down in a Paper Trading Log, keeping track of daily profits and losses, and monitor your other orders such as “stop losses”.

For example, if on the next day March Corn settled at $2.25, your paper trade would have an open profit of $150. A contract of corn consists of 5,000 bushels and the units quoted are cents per pound. The price dropped 3-cents, and because each cent equals $50, we get $50 x 3 = $150. To find contract specifications go to the Contract Specification page.

Tracking your paper trades has in the past been done literally on paper, in a notebook for instance. This process entails manually updating charts, looking at the daily newspaper for quotes, writing in entry/exit prices and hand-calculating profits and losses. This is very time consuming. Also, because prices are being taken from the newspaper trades can only be updated daily. A better method would be to use an online service such as PAPERTRADER® Online which will allow you to have multiple accounts, establish different beginning balances and rates, and will dynamically calculate your profits/losses throughout the day.

Common Pitfalls: WARNING

Everyone is a millionaire on their paper trades”. That phrase says it all, but to elaborate, be aware that paper trading has severe limitations as a predictor of your ultimate success in the markets. The reasons for this are many…and include but are not limited to:

• Emotion – With no money at stake, fear and greed will not influence your decisions. You’ll find yourself doing things you wouldn’t normally do with real money. Think about playing poker with pennies as compared to using $100 bills, you’d play much differently in both circumstances.
• Unrealistic Account Balances – If you start paper trading with $1,000,000 yet only have $10,000 to open a real account with, the performance of your million dollar account will likely have little or no relevance to the performance of your real account. The larger account will allow you to trade markets with large margin requirements such as the NASDAQ 100 with a margin of over $20,000. With $10,000 you won’t be able to trade everything you’d like or be in more than a few markets simultaneously.
• Can’t Simulate Market Conditions – In the real world there is slippage on fills, some orders may not get filled, there are “fast” market conditions, illiquid markets and thin conditions, gaps, locked limit moves, etc. These cannot be accounted for realistically with paper trading. You may want to add a few dollars to your commissions on your paper trades as a buffer in an attempt to account for these conditions.

Final Comments

To summarize, paper trading is a learning process whereby you simply pretend to be trading. There is the traditional method of tracking your paper trades, on actual paper, or you can use an Internet service to do the work for you. Always keep in mind however that paper trading is no substitute for real trading and the results you have on paper aren’t likely to be replicated in reality.

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DISCLAIMER:  Futures Trading involves a huge risk of financial loss!  FuturesKnowledge.com is a traders research and resource site - and is not meant to be used as a guide for trading.  Due to the large risk involved - we highly recommend that you consult with a number of different resources before attempting to invest in the futures, commodities, options, or any other market we report on.

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