What Is A Simulated Trading Account And Why Should I Use One?
Simulated trading accounts / simulated trading, often called “paper trading”, “virtual trading”, “virtual account”, or simply "Sims" or "Sim Account" is generally a trading account setup by a broker to provide a real life experience of trading without actually using real money. A sim account can be very simple; a personal journal with the trader looking up the closing price could be a sim account, to very sophisticated broker accounts that try to closely mimic true buys and sells along with tracking profit and loss in real time.
Sim accounts are one of the best trading tools available to new traders as well as seasoned traders adding new techniques in trading. It’s easy to find brokers offering sim accounts with starting balances of $25K, $50K, and $100K. The amount really doesn’t matter as long as you are able to execute your trading strategy the same as you would in an account with real money.
One of the biggest complaints about trading with a sim account is it lacks the “thrill” of a real trading account and removes the emotional element. That is true for most people and there is one very important caveat to the statement that should be heeded. You do NOT want your trading to be “thrilling” or exciting or really even to raise your pulse rate (much). The thrill you feel with real money is part of the fight or flight response and while it may be enjoyable to receive the “gambling high” as a result of the various chemicals your brain is ordering released, it doesn’t make trading more profitable or improve decision making. In fact, I believe based on the many books I have read on the subject that the same changes causing the gambling high will cause you to make poorer decisions and cost you money.
While many will say that are trading for money, they are trading for the thrill of it and to various degrees. Here is a quick question to ask yourself to see if you’re motivated by money or by thrill. If you are not making as much money as you would like to make, are you willing and able to stop trading (or not start) and simply sim trade with total dedications (same amount of time everyday that you will or are putting in) for one week? If you can’t sim trade for one full solid week, and you have not already proved you’re making as much money as you want, you need to take a series look at priorities. You’re likely looking to get the thrill as much or more than to money.
The best use of a sim account is to become familiar with the layout of your broker account and to practice executing entries and exits from trades and or investments. It’s easy, too easy for many to enter into a trade. Many traders will look at a chart briefly and form an opinion about the direction. The problem with this is that people are hard wired to seek patterns and we will find them even when they do not exist. A great example is when you or someone else looks into the sky and sees a picture of something in the clouds. We all know it’s not really a picture of whatever but a common response after looking is to say “oh I see it” and it is because you see a pattern resembling something else even though it’s a random formation of clouds. You have to be very careful when trading because the same parts of your brain will see patterns in a chart that really are not there in the sense of having a statistical edge in placing any given trade.
Sim trading will allow you to naturally enter and exit when your written plan calls for any given course of action. It’s very healthy to practice your stop loss exits over and over. Once you get used to exiting a loser without a care in a sim account it will be easy or easier when real money is on the line. I have read that do make something a habit you must repeat the action over and over for several weeks (21 or more days). Think how great it will feel to be able to exit a loser without a care, and to hold positions without worry because you know the trade will either work out or it will not, but you will still be in the game making money tomorrow.
Sim trading will allow you to lower your stress level on winning and losing trades. With sim trading you can work on your trading plan and fine tune it with practicing executions and not lose money when you make mistakes. It’s hard to calculate how much mistakes will cost you, but in over 20 years of trading I do not know one person who would have guessed they would lose as much money as they have to making mistakes. Simulated trading will help lower your cost of mistakes.
Another way to think about sim trading is what pilots do. Pilots go into simulators before flying the real thing. There are two real easy reasons for this. Firstly, it costs less to use a simulator (same with trading), and secondly pilots get to become good at making the correct decisions under pressure without real risk (same with trading). Army tank personal, Navy Submariners, and police all practice in a simulated environment to become good at what they do. If it makes sense for all of these risk takers, it’s hard to argue it doesn’t make sense for you IF you truly want to be a professional trader and not simply a thrill chaser.
There are drawbacks with simulated trading that need to be understood. Since your orders are not actually getting placed or executed in the real world, your trading has zero market impact. This may not mean much if you are willing to account for paying the spread on each transaction and you are not trading a relatively large size. For example if you are sim trading the S&P 500 e-mini futures during normal trading hours using an order size of one or two contracts and paying the spread (buying at the asking price and selling at the bid price) you are likely to get real world results. On the other hand, if you are trying to simulate trade options on a thinly traded stock and not paying the spread because you hope to make a market, you may find the simulated results to be far superior to the real world results. This is really only a problem if you don’t account for the likely differences between real world trading and simulated trading.
Do you have questions about simulated trading or want to share your experiences with paper trading? Feel free to use the comment section below to ask.