Key Takeaways

Know that it’s harder to keep emotions in check when you know the money is real

Pull and assess a sample of paper trades as a simulation of potential profitability

Be honest with yourself

Paper trading—aka simulated trading, such as on the paperMoney simulator on the thinkorswim® trading platform—allows us to answer a lot of questions about ourselves before actually committing that hard-earned capital to the markets. If we drill down on a deeper level, that’s really what paper trading is all about—a psychological study and revelation of who we are and how we react under changing market conditions.

Many traders approach paper trading to develop a strategy and test it out. It’s a valid approach—but it’s only half the equation. In reality, our trading strategy takes a back seat to how we manage ourselves and our trades in the markets. If you find yourself ecstatic about winning trades and despondent about losing trades, it’s probably fair to say you’ve got a ways to go to understand paper trading versus live trading.

Paper trading can help with this. Once you’ve gotten to a level where you’re indifferent about winning trades versus losing trades, you might find yourself ready to take that disciplined approach to the live platform. Many veteran live traders aim to be emotionally detached, objective scorekeepers.

Why all this talk of emotions, discipline, and mental toughness? In a word: money. Real money, to be exact. Many paper traders think they can flip the switch to real money and feel no differently, but when they get there, they find the transition harder than expected. 

The Key Objective of Paper Trading

If you’re looking to develop the holy grail of trading strategies—you know, the one that wins all the time and nobody else has ever thought of—you might find it an exercise in futility. First, that strategy doesn’t exist, and second, often the strategy isn’t the issue … it’s us. 

There’s an adage among trading circles: “It’s not the trading system that fails the trader; it’s the trader that fails the trading system.”

One objective of paper trading is to develop a trading system, work out the bugs, and observe how you react over evolving market conditions. Are you disciplined enough to follow your rules to a “T”? If not, you might want to keep the trading platform in simulation mode.

Trading Options in paperMoney? Understand This Big Difference.

Standard U.S. equity options are American-style options, meaning they can be exercised any time before expiration. In contrast, you’ll never be assigned a short option before expiration in the paperMoney simulator.

Before you switch over to live options trading, make sure you understand the ins and outs of expiration. Short call positions are particularly vulnerable if a company is about to issue a dividend.

How to Switch From Paper Trading to Live Trading in thinkorswim

So, you’ve developed a rules-based system for entering, holding, and exiting the markets. Now you feel like it’s time to put yourself to the test. Assuming you have your position sizing and risk management numbers down, pull a sampling of your trades and do a full assessment of the numbers.

Committing to a sample of trades helps you get away from living and dying by your last trade and allows you to score yourself over a range of market conditions. The sample size is at the trader’s discretion. A minimum of 20 could be a starting point. More samples means greater accuracy in performance.

And don’t cherry-pick the data—be as scientific as you can about it. There’s no incentive to cheat here. As Mom used to say, “You’re only cheating yourself.”

Once you’ve completed your sample assessment, it’s time to stop and score yourself. You’re going to look at your percentage wins and average win size versus your percentage losses and average loss size. Once you have those numbers, you can plug them into the expectation formula (which sounds more complicated than it is):

Expectation = (% win x average $ win) – (% loss x average $ loss)

If the output of that formula is a positive number, it could be an indication to move to the real platform. If you were disciplined enough to follow all the rules of your system and remain emotionally detached, you may be ready to try to duplicate the process in live trading on the thinkorswim platform.

If not, consider going back to the drawing board. Think about where you might’ve gone wrong. Were your trade sizes out of proportion with your risk per trade? Were you too quick to take winners but hung onto losers too long? That’s the win/loss conundrum, and there’s a potential fix for it.

Either way, remember your sample is just a sample. Like all scientific studies, the numbers can tell you probabilities about a hypothesis but not guarantees.

The Bottom Line on Paper Trading vs. Real Trading

In theory, there shouldn’t be any psychological difference between how we trade on the paper side versus the real side. But our minds and egos are sometimes tricky participants that can trip us up if left untrained.

This is where paper trading can really help get these two factors—the mind and the ego—trained and under control. So, go ahead: Develop your system, start paper trading, and score yourself over a sample size of trades. The outcome will be very revealing in terms of where you may have gaps in the system. Once you fill these gaps, you might see that expectation formula outcome rise, and with that, you may decide it’s time to start live trading. You’ve earned your stripes!

The place where trading risk doesn’t exist.

Try paperMoney

The paperMoney software application is for educational purposes only. Successful virtual trading during one time period does not guarantee successful investing of actual funds during a later time period, as market conditions change continuously.