This is a question that I got from one of my subscribers, so I'll answer it here. Paper trading is a good exercise for beginners, but you don't want to be stuck doing it for too long…or stop before you're ready. So let's take a look at how to find the right length of time to paper trade.
Traders should paper trade until they can meet or exceed their monthly percentage return goal, averaged over a 4 month period. For example, if a trader has the goal to make 2% per month, then the trader should make at least 8% profit, over a period of 4 consecutive months. Traders that are using a longer-term swing or position trading strategy should consider paper trading for 6 months to a year because there will be much fewer trades.
Now let's take a closer look at what paper trading is, how get started, and how to set goals.
What is Paper Trading?
Paper trading is when a trader takes simulated trades, with the goal of learning how to become a consistently profitable trader.
Before computers were widely used, traders would write down their simulated trades on paper, thus giving it the name “paper trading.”
Now many brokers in the stock, options, futures and Forex markets offer online paper trading accounts. They are also known as demo accounts.
These accounts allow traders to execute trades as if they were trading with real money. The website keeps track of the trades and the trader can see the profit/loss from each trade.
This makes it easy to test strategies and learn the mechanics of placing trades, without risking real money.
Set a Paper Trading Goal
The first step in effective paper trading is to set a goal. If you don't have a goal, you won't know when you should stop paper trading.
Some traders say that you shouldn't have a goal, because that will affect your trading psychology.
Not having a trading goal is like saying a Formula 1 driver shouldn't have a target lap time.
…or a competitive weightlifter shouldn't measure how much they are lifting.
You need to have a target.
Yes, it's true that you won't hit that exact target all of the time, and you shouldn't get too wrapped up in hitting that target every month.
But you should have a good idea of the average return of your trading strategy.
So the next question becomes: What should your first goal be?
There are many legitimate ways to answer that question, but I feel that you should start small and build from there.
Pick a small number like 1% a month, 3% a quarter or 12% a year.
If you can average 1% a month consistently, you can probably make more by adding more trading strategies, timeframes or markets. If you can't hit that small number however, then it's impossible to every earn more.
Define Your Strategy
Next, write down your exact trading strategy and prove that it has an edge.
You can prove this by jumping right into paper trading with play money, but a better way is to backtest it to see how it would have worked in the past.
I've created a simple trading plan worksheet here. Print that worksheet, fill it out, and you'll have a complete trading plan.
You can also use a simple Google Doc, Evernote…or whatever works best for you.
The key is to write it down and follow the rules every time you take a trade. Keep your trading plan next to your computer, or open it on your computer before trading.
Once you have a trading plan, now it's time to open a paper trading account.
How to Open a Forex Paper Trading Account
In order to open a paper trading account in Forex, simply go to the website of the broker that you'll be trading real money with, and open a demo account.
When you visit a broker's website, there should be a link to open a demo account.
Follow the instructions on how to setup the trading platform and start paper trading. The process of opening an account usually only takes a few minutes.
From there, it will take some time to setup the trading software. Brokers will use trading software like MetaTrader, TradingView, or have their own proprietary platform.
This will also give you the opportunity to master the trading software and test out the broker's customer service team.
Most brokers will allow you to adjust the amount of money in your demo account, so you can trade with numbers that are realistic to your situation. If you want to have a demo account that doesn't expire, consider using Oanda.
To see a list of Forex brokers that I recommend starting a demo account with, go here.
How to Open a Stock Paper Trading Account
There are different paper trading platforms for stock trading available, but a good one to start with is Thinkorswim by TD Ameritrade. They offer a paperMoney account that will allow you to demo trade stocks.
I've found the Thinkorswim platform easy to use, and it's great for both new and experienced traders.
Is Paper Trading Accurate?
It depends on which market you're paper trading.
In my opinion, Forex is the best market to paper trade. Almost all brokers offer a demo account, where you can simulate live market conditions.
Since Forex is so liquid, a demo account is a very good approximation of how you will do in a real-money account. So I consider Forex the most accurate market to paper trade in.
Paper trading in other markets like stocks, options and futures, can be less realistic because certain stocks or contract months can have low liquidity. When there's low liquidity, you are much more likely to see slippage in a live account, or not be able to get your trades executed at all.
Therefore, paper trading in stocks, options and futures can be less accurate. But you should still do it because it's a great tool for learning how to trade.
How Do I Know When I'm Ready For Live Trading?
Once you can hit your paper trading target, now it's time to make a decision if you want to jump into real-money trading or not. Only you can make the call on when you should start risking real money.
One thing to consider is your personality type.
There are 2 ends of the personality spectrum to consider before stepping up to live trading:
- Are you someone who tends to be very impatient? If yes, then you should probably paper trade for a couple extra months to be sure that you are ready.
- Are you someone who tends to over-think things and always wants to get “more information?” If yes, then you should probably jump into a small live account as soon as you can hit your target average monthly return over 4 months. Otherwise, it can be easy to get stuck in the cycle of trying to learn more.
- If you're in the middle of the spectrum, then be honest with yourself and ask if you're truly ready to start risking real money.
These are only general guidelines, based on what I've seen over my 13+ years of trading experience, and talking to traders from all over the world.
Do what you feel is right for you.
The amount of paper trading time that's required to master a trading strategy will vary greatly by trader.
We all have very unique personalities and there's no one-size-fits-all formula for how long you should paper trade.
However, if you follow the guidelines above, you will get to a point when you will know that you're ready to stop paper trading, and start trading real money.
When you feel like you're ready to risk real money, start with a small account. There may be unforeseen psychological challenges that you may have to get used to.
Also read my Forward Testing Guide for more tips on how to do effective paper trading.
Finally, believe in yourself and that you will know when the time is right for you to stop paper trading. Take control of your personal power and don't give it away to someone else by blindly following what they tell you.
Let your data and common sense show you the way.