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Paper Trading Options

Updated on April 28, 2010

Paper Trading Options

So what would be the benefit of paper trading options, or paper trading anything for that matter? Some might argue that it’s a waste of time, and that you just need to “jump right in” to the markets without any prior preparation, because there’s no teacher like experience, right? Well, there’s more to paper trading than meets the eye, and if you maintain an open mind about it, it’s very possible that you’ll begin to derive great benefit from it. Paper trading, for those who may be unfamiliar with the term, is basically a “fake” trading account that you maintain and oversee, where you place fake trades based on actual market movements, just to get a feel of what the markets would be like if you were trading them with real money. To many, paper trading provides a way to refine their trading techniques and philosophy, as well as to hone their skills of identifying the proper entry and exit points in the market during real trades. When you paper trade options, you use actual market data, and select whatever option chain you want to follow, and then you select which option out of the chain you want to actually purchase (or sell, if you’re writing the option), then you place a “fake” order, you determine your entry point based on the most likely price you would have been filled at if you were to have placed the order for real, and then you monitor the trade every day, keep track of daily profits or losses, and then finally place a “fake” order to exit the trade, and determine the final net profit or loss of the trade. All of this is for the purpose of understanding and refining your own trading methodology even better, and for you to understand what moves you may make based on how the price action of the market is flowing.

Image courtesy of Microsoft Office Clip Art
Image courtesy of Microsoft Office Clip Art

Paper Trading Options: Virtual Trading

When paper trading options, you have to keep in mind that with many of the virtual or fake trades that you place, actual market conditions may vary greatly from how it played out in your virtual trade. A cool thing that many online brokerages (and even the CBOE now) have done is to give all account holders access to a virtual trading platform, where you can basically paper trade options using real order screens. The virtual trading software will track your trades and tally your profits and losses, just as if you were really in the actual trade. You start the virtual account with an amount of starting capital, and any trading profits or losses you incur will be added to (or deducted from) your virtual account balance. It’s really no different than a flight simulator that a pilot would use for training purposes; these types of virtual trading accounts can provide good training and give you a decent real-world feel for how trading the markets actually works. I would highly recommend paper or virtual trading to newcomers to the markets, simply because it gives you a better understanding of how real-money trading works, without the risk of losing real money. If you want my personal recommendation, OptionsXpress has a great virtual trading platform if you are an account holder (which I am—shameless plug for them right there). They provide this virtual platform for stocks, options, and commodities. One caveat that I have to mention is that although paper trading options can give you a great starting education, and I highly recommend that every beginning trader do LOTS of paper trading before starting to trade with real money, I must admit that once you have real money on the line, your emotions come into play, so your performance with the virtual trading account may or may not match what you will do in a real-world trading environment. I can personally attest that there are a lot more emotional challenges and personal discipline challenges you have to face when real money is on the line. Just keep that in mind; I’m definitely not knocking paper trading options or any other derivative for that matter, but just remember, you never fully know how you’re going to do until your actual hard-earned money is on the line.

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