Paper trading defines a simulated market environment in which the participant writes down buying and selling decisions, rather than placing actual orders at a brokerage. A paper trade refers to using simulated trading to practice buying and selling securities without actual money being involved. New traders are often instructed to paper trade until they learn basic strategies, while many experienced traders utilize the practice from time to time, especially when working on new ideas and approaches.
Paper trading is when you plan trades but do not actually invest any of your capital. You choose a position size, an entry point, and exit point. The planning process is virtually identical to that of planning a real trade, however you do not actually put money into the trade. Traders can do this by using a simulator or simply by recording their trades on paper (thus, the name). This practice can provide valuable experience and insights, whilst also protecting a new trader.
The simplest approach to paper trading identifies an appealing trading instrument (currency pair) through a chart on a website or an analysis by a market personality, writes down the ticker and chooses a time to place a hypothetical buy order, or sell order if desiring to sell short. The novice jots down the opening price if entering at the start of the session, or watches the chart and ticker during the trading day, picking a spot that looks like a good entry.
The choice of entry price and time varies considerably, depending on the basic tutorials used to learn the trading game. The same holds true during the management phase, when deciding where to place the stop and how long to hold the position. Whatever the approach, an exit price is finally written down and the novice repeats the process until enough data is gathered to analyze progress. To derive the most benefit from paper trading, it should be taken seriously with investment decisions made based on the same risk-return objectives, investment constraints and trading horizon as if it was a live account.
Despite all the benefits what paper trading can provide, many profesional traders will agree that paper trading is the most counterproductive way to learn how to trade properly. When paper trading, every single trading decision is based on zero emotions. You are actually training yourself how to decide entry and exit targets based on no risk. It is a fact that the greater the risk, the greater the reward. As paper trading has zero risk, it has no reward. It will actually increase your risk to gain reward when you start to trade with real money because you have been teaching yourself how to make decisions that do not apply in the real world.