A great way to learn options trading is through paper trading.  But as you’ll soon learn, there’s a right way and a wrong way to approach paper trading.  This article will get you started in the right direction.

Paper Trading Options The Old-Fashioned Way

Although you may be all pumped for some online paper trading, you can still do this (and there is some benefit) to doing it the old fashioned way.

Not long ago there was an article in the Wall Street Journal about how writing by hand gives children and even adults better recall of what they are writing down. You don’t get the same brain to hand connection using a computer.

I would link to the article, but I’ve noticed that over time, the articles get moved or put into an archive. If you want to read more about it do a Google search on the subject and you’ll find the material or similar studies.

The point being, don’t scoff at doing paper trading, with pen and paper. Actually writing it all out by hand will make you a better trader. Many of the old school chartists swore by learning the markets by hand charting them.

Of course, this was before computers, but modern science now backs up their pronouncement. Even if you do end up paper trading online, don’t rule out copying it down into a notebook as well.

Is it too much trouble to truly become a better trader (which means making more money ultimately)? If you are solely doing real paper trading (no online services), then there are a few caveats you need to watch out for.

1. Watch the bid/ask spread. Make sure you are buying at the higher price in the bid/ask spread and selling at the lower price. If you don’t, you aren’t getting accurate results in your practice. It will make you think you are doing better than you are and real trading will be a shock, as in expect to endure losses you wouldn’t have in paper trading.

2. Options are not always the most liquid thing. If you’re writing your trades down without the help of a brokerage, you’ll be okay as long as you check the open interest and volume numbers on a site like Finance.Yahoo.com. If the option you want to buy or sell has zeros for the open interest and volume, you need to assume that while you may be able to buy one or two at the posted bid/ask, buying more than that would undoubtedly move the market against you, meaning that you’d get a fill that was more expensive.

Better to stick with very liquid options in paper trading to avoid unrealistic, pretend returns. A good rule of thumb is to look for options with open interest in the front month of 1000 or more.

Using a Broker’s Platform

Far easier than trading strictly with pencil and paper is using the paper trading function of an online options broker. Optionxpress.com and OptionsHouse.com both have virtual trading environments you can practice with.

OptionsHouse doesn’t require you to fund the account to paper trade. That is a nice feature if you just want to try it out and get your feet wet, so to speak, before committing money to a broker.

I believe that Optionsxpress.com also lets you use their virtual trading platform without depositing money, but I’m not 100% sure on that. I have a funded account there, and I didn’t try to use their paper trading system until after I’d funded my account. However, in all likelihood, you can use their platform free as well.

Most other brokers will offer paper trading as well, but I’m only mentioning those two as they are the only two I’ve used myself. If I had to pick between them, I like the system on OptionsHouse.com better. It’s clearer and the data is presented to you in an easier to understand format (in terms of gains and losses, the greeks, etc.).

If you are hesitant to open an account with a broker, you could also use the service at Simulator.Investopedia.com. You have to register for a free account, and they will try to get you to sign up for some email newsletters and offers related to trading. However, you don’t have to opt into anything.

The simulator at Investopedia.com is limited. As of this writing, you are only able to buy puts and calls. On their site they say in the future, they will add option writing capabilities. So, by the time you are reading this, their simulator may have full functionality.

The Reality Test

When paper trading, you are playing with play money. It’s easy to try and go for the big score. In fact, the paper trading competitions encourage it with their outrageous returns posted by the winners. Notice that no one posts those kinds of returns in real life over any length of time.

The reason is that the winners of those competitions are trading unrealistically. It’s easy to fall into that trap. You don’t want to do that. The point of paper trading isn’t to post unreal returns that can never be achieved.

The point is you want to approach each pretend trade with the reality test. If this were real money, would you make this trade? It’s easy to be brave when the risk of loss isn’t real.