Paper Trading: A Test Run of the Theory
Risk is present in all forms of investing. One of the troubling aspects to any new investing idea is this basic risk, and with options the lack of knowledge or experience adds to the overall risk. Anything new you try invariably will involve placing money on the line, even when you lack the experience to know for sure that the concepts will actually be profitable. So anyone new to options trading faces a dilemma: How do you gain experience without placing capital at unacceptable risks? And how do you know if a risk is acceptable until you try a trade for the first time?
This problem keeps many people away from options altogether.
Smart Investor Tip
Paper trading works best when it simulates a real-world environment. This should include limitations on portfolio size, timing, risk, and level of transaction you are allowed to execute.
- Ease of use. The most important feature for any web site is how easy it is to use. No one enjoys having to struggle with a complex or slow web site.
- Realism. Your paper trading experience should approximate the real trading environment as much as possible. So rules should apply just as they do in your trading account with a broker.
- Trading-level distinctions. In the real world, brokers will assign you a trading level based on your knowledge and experience and also on the cash level in your account and volume of trading activity. A paper-trading web site should provide you with one of two trading capabilities. First, if you use a site that restricts your trading activity, you will learn to function within your level of experience. Second, if you are allowed to execute any risk level of trade, you will quickly learn firsthand about risk and how some options theories end up being very costly. So pick a site that provides you with the level of experience you seekârealistic based on your knowledge level, or unlimited based on your desire to try even advanced and exotic strategies.
- Ability to trade both stocks and options. You want a paper-trading site to provide you with a realistic trading environment, even though you will be making only mock trades. In order for paper trading to provide you with valuable experience, it should be as close as possible to the real world of stock and options trading. You should be allowed to trade both, so that you can experience the cash limitations, risk dynamics, and interaction between stocks and option values.
- Provision of valuable support services. A site offering paper trading is most valuable when it offers additional services. These include educational services, such as publications, articles, and useful links. Many sites have options glossaries or bookstores, links to options market experts, and stock and options quotation services. The more extensive the level of additional services, the greater the value to a paper-trading site.