Paper Trading & Backtesting Tools – Stock market simulators for virtual stock trading and backtesting without risking money

Introduction to paper trading and backtesting to evaluate investment and trading strategies

Trading and investing on global markets are now accessible to anyone with as little as $500. However, there is a learning curve and losses are inevitable during the learning phase. Paper trading with a stock market simulator allows you to learn in real time, using live market data, without risking a cent. You can also back evaluate your trading strategy to make sure it has an edge before you risk real capital on it.

Paper Trading & Backtesting Tools - Rules Based Trading Strategy
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This post will give you an introduction to paper trading and backtesting, why they are useful, and how to get the most out of a stock market simulator. We have also listed our preferred demo accounts (for paper trading) and backtesting tools to help you find the right tools to succeed in trading and investing.

Some terminology

Investor / Charts
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Before we begin, we should outline a few terms related to paper trading and backtesting.

  • Paper trading allows you to practice trading without risking real money. You simply log your trades in real time in a journal, spreadsheet or stock market simulator as if they are real trades. However you choose to do it, you need to make it as realistic as possible. So, you can only use the current market price and you must account for slippage and the commission you would pay if you were trading with real money. Paper trading is sometimes known as demo trading, virtual stock trading or simulated trading.
  • Backtesting is the process of evaluating a trading strategy using historical data. Typically backtesting is done using software, but it can be done manually by logging each individual trade. Backtesting can only be used for rules-based strategies where each trade follows exactly the same set of rules for trade selection, entry and exit. When you backtest a strategy, you will be looking at the performance over a series of at last 20 trades to see what the overall results will be.
  • Live trading is simply real trading with real money. Obviously, live trading in the real market is the objective for any trader. But live trading with a very small amount of capital can also be part of the practice and testing process, along with paper trading and backtesting.
  • Demo accounts, which are also known as stock simulators and virtual trading accounts, are trading accounts that let you trade with virtual money. Most stock brokers offer paper trading with a demo account like this. Not only does this allow you to practice trading and evaluate your strategy, but you can also get to know a trading platform before you put real capital on the line.

Why paper trade or backtest before you risk real money

Why Paper Trading and Backtesting
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Trading is a numbers game, and the reality is that there is a fine line between being profitable and unprofitable as a trader. Backtesting and paper trading help you increase the chances of being on the right side of that line. Not all trading methods can be backtested. But if you can backtest a strategy, you will know what to expect when you go live. By backtesting your trading strategy you can:

  • see how the strategy would have performed in the past,
  • calculate your win rate and reward to risk ratio,
  • find out when the strategy might fail, and,
  • optimize the parameters of the system to improve performance.

By paper trading your strategy you can:

Investor Paper Trading & Backtesting
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  • evaluate the strategy in real time,
  • Compare real time results to backtest results,
  • find out how much slippage you can expect, and,
  • see if there are any other issues related to real time execution.

In addition to testing strategies, paper trading is a useful exercise for traders of all levels:

  • Beginners can use paper trade accounts to learn how emotions can affect decision making. 
  • Traders can get to know a new trading platform with a demo account before risking capital.
  • You can experiment with different order types and risk management strategies.
  • You can build confidence after a difficult period. Even the most experienced traders sometimes revert to trading with a stock market simulator after a string of losing trades.

Paper trading vs. backtesting vs. live trading

Paper Trading vs. Backtesting vs. Live Trading
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Ideally the process of developing a new trading strategy should include the following steps:

  • Backtesting and optimization
  • Paper trading
  • Live trading with minimum possible capital
  • Live trading with increasing amounts of capital

Each of these steps can teach you something new about the strategy and minimize the amount you put at risk before you are sure it’s profitable. The reality is that you may not be able to use each step for every approach to trading. There are also a few distinct differences between backtesting, paper trading, and live trading in respect to when and why each is useful.

Rules based strategies vs. discretionary trading methods

Trading / Day Trader
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You can only backtest a strategy that can be expressed as a set of rules that can be expressed as a computer program. Typically this means trading systems that are based on technical analysis indicators like moving averages or oscillators, but fundamental data can also be included. If your approach is discretionary or based on “gut feel”, it will be difficult to backtest. In this case, paper trading becomes even more crucial to evaluating the strategy without risking your capital.

Many trades vs. one trade

Investor / Stock Research
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An important distinction between backtesting and paper trading is the number of trades involved in each iteration. A backtest produces a series of trades which can include winning and losing trades both big and small. But the way you view performance will be by looking at the total profit or loss, which won’t emphasize the best and worst trades. When you are paper trading or live trading, you will be focusing on one trade at a time, and this will give you a very different perspective. This is why it’s so important to do both as often as possible.

Execution

Trade Execution / Trading Signals
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When you backtest a strategy, you will assume your execution occurs at a price based on historical data. You can use the closing price of the bar when the trade is triggered, the open price on the following bar, or an average based on highs and lows. In reality there will be difference between the price you would like to trade at and the price you actually trade at. This is your slippage, and you need to account for it, along with trading fees, in your trading system.

The only way to get a realistic idea of what slippage you can expect is by paper trading and then live trading. Even paper trading may not give you an entirely realistic idea of how your execution will differ from a backtest – and this is why live testing should also be a part of the process.

Paper trading and the psychology of trading

Cycle of Market Emotions
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Trading is not just about managing your financial capital – you also need to manage your psychological capital. Your decision making will be affected when you make money and when you lose money. This is why fear and greed play such a big role in the market.

Ultimately, to be a successful trader you need to manage your psychological capital so that you can make good trading and investment decisions regardless of what’s happening to your P&L. Chances are that you will only learn to do this properly by trading with real money. This means that you shouldn’t expect paper trading success to immediately translate to live trading success.

It also means that when you start trading live, you should start out with the smallest position size possible. Some people even believe that paper trading is so different from live trading that it can have a negative effect on your education as a trader. We feel there is still a lot of value to paper trading, but it’s important to be aware of the drawbacks.

Stock market simulators: Demo accounts vs. trading games

Stock Market Simulator
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In this post, when we refer to stock market simulators, we are talking about demo trading accounts. Stock market games are another type of stock market simulator. These games typically involve a social element where you pick a portfolio of stocks and see how it performs against the portfolios of friends, or contestants in a competition.

These games are fun and a good introduction to the stock market. They can also be educational if you want to focus on long-term investing and stock picking. But, if you want to develop real trading skills, paper trading stocks is a more valuable exercise.

Pros and cons of paper trading

Pros / Cons Paper Trading
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Like most things related to trading, there are pros and cons to paper trading.

Advantages of using a stock market simulator

  • You can learn the process of trading without putting real capital on the line.
  • You can learn to trade while saving capital to begin trading with.
  • You can test a strategy to see if it’s really profitable.
  • You can rebuild confidence after a losing streak.

Disadvantages of using a stock market simulator

  • There is a psychological difference between paper trading and live trading which still needs to be overcome.
  • You can get a false sense of security after a lucky streak paper trading, and then begin live trading too soon.

How to get the most out of your paper trading

Tips for Paper Trading
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The key to getting the most out of trading with a stock market simulator is to take it seriously and make the experience as realistic as possible. There are several ways to do this. When you open a demo brokerage account, you will typically be given $100,000 or even $1 million in virtual currency to trade. Unless you actually plan to trade with an account of this size, try to change the account to a more realistic size. The amount you risk on each trade will then have more meaning to you.

You should also make sure your stock market simulator is including trading costs in the P&L. Always enter trades in real time at a price that you could realistically execute your order at. There is often a temptation to add trades that you missed after the fact. Missing trades is part of the deal, and should be reflected in your paper trading results. Be deliberate. Follow a trading plan and keep a journal with reasons for entering and exiting trades.

One thing you can do in a paper trading account that you wouldn’t do in a live account is to experiment. You can try doing the opposite of what you think you should do, or taking the opposite side of a trade. This is fine as long as it’s all part of a deliberate process of learning and experimenting. Focus on your P&L, win rate and win/loss ratio over a series of at least 10, but preferably 50 or more trades. Try to worry less about individual trades and more about the overall returns for a series of trades.

Choosing a stock simulator or demo account

Choosing Stock Simulator
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When it comes to choosing a stock market simulator, there are obvious benefits to first choosing a broker you want to trade with, and then using their demo account. This will allow you to get used to the platform while paper trading. You can also use the demo account as a way to evaluate a broker, and then commit capital when you are happy with the platform. Typically you do not need a funded account before you open a demo account. There is also no reason not to try out a few different demo accounts while you are paper trading. When evaluating demo accounts, you may want to consider the following points:

  • Does the demo account use real time data or delayed data feed? To get realistic real-world experience you should be using real time data.
  • Are realistic trading fees deducted from your P&L. Trading fees are a part of trading and should always be included when paper trading or backtesting.
  • If you plan to trade with margin (leverage) you should check that you can do this with a demo account.
  • When you are using a demo account, try to cross reference the prices with a live feed and work out how realistic your execution prices are. 
Investor / Stock Market
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As mentioned, most brokers offer demo accounts. The following are a few demo accounts we think stand out from the crowd for one reason or another.

TD Ameritrade

TD Ameritrade
TD Ameritrade

TD Ameritrade is one of the more established online brokers around. The platform offers a wide range of features, tools and instruments to trade. TD Ameritrade’s stock market simulator, paperMoney, is one of the most advanced around. The demo account falls within the ThinkorSwim platform suite which includes a lot of educational resources to help you learn while you paper trade. While using the demo account, you will also have access to most of TD Ameritrade’s tools, research and data. You can also experiment with short selling, option strategies and other asset classes like forex and futures. 

Interactive Brokers

Interactive Brokers
Interactive Brokers

Interactive Brokers is another well established online trading platform which is favored by professional money managers as well as retail traders. The platform is more complex than most, and it will take you longer to get started. However, it also offers more tools than platforms that are built primarily for retail traders. Interactive Brokers will also give you access to more markets and instruments.

IB also offers fractional shares which allow you to allocate specific percentages of a portfolio to each stock. An Interactive Brokers demo account will give you access to almost all the tools you would have for a funded account. You will also have access to extensive research and educational resources.

NinjaTrader

NinjaTrader
NinjaTrader

NinjaTrader is a trading platform with a focus on futures, options and forex. The platform is not a broker, but provides market access via a choice of brokers, including NinjaTrader’s own brokerage service. NinjaTrader is a popular choice for futures traders and traders who focus on technical analysis rather than fundamental analysis. A NinjaTrader demo account offers simulated trades and backtesting, as well as the ability to replay historical data to paper trade on.

Webull

Webull
Webull

Webull is a newer trading platform with a focus on simplicity and mobile trading. The platform only offers stock and option trading, but charges no commission on trades. It doesn’t offer nearly as many features as the other platforms we’ve mentioned – but the learning curve isn’t nearly as steep, and you can get started very quickly. It’s also a great choice if you want to trade on a mobile device. Webull’s demo account will give you access to all the desktop and mobile app features.

Pros and cons of backtesting

Backtesting a trading strategy can tell you a lot about how it has performed in the past, and may perform in the future. While we can be fairly certain the future will be different, knowing a strategy’s strengths and weaknesses can be invaluable. If a strategy didn’t perform well in the past, it’s unlikely to perform well in the future. However, it’s worth keeping the benefits and drawbacks of backtesting in mind.

Advantages of backtesting

Stock Market Analysis / Backtesting
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  • Backtesting tools show you whether a strategy was profitable in the past.
  • You will know what sort of drawdowns were experienced.
  • Using backtesting tools is a very efficient (time saving) way to test a strategy with hundreds or thousands of trades.
  • You may be able to see what market conditions led to underperformance, and you may be able to apply filters to avoid trading when those conditions arise.
  • You can optimize parameters to improve risk adjusted performance.
  • You can remove indicators or rules that don’t add value.

Drawbacks of backtesting

  • In practice, real world results are almost always worse than the results of backtests.
  • There is a temptation to over optimize a strategy so that it performs very well over a specific period of historical data. This is known as curve fitting or overfitting.
  • A trading strategy will still need to be tested live to determine slippage and trading costs.
  • You may become overconfident based on the results of an initial backtest. This often results in rushing to begin live trading without exhaustive testing and testing on a stock market simulator.
  • There is an inherent bias toward creating strategies using patterns that you know have worked in the past.
  • On short time frames, like day trading, execution plays an enormous role in performance. Backtesting can still be a starting point for day traders, but paper trading is more important.

How to get the most out of backtesting tools

Trading / Backtesting
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Backtesting should always be done on separate data samples. This is known as in-sample and out-of-sample testing. Initial tests are done on the first sample, and then the strategy is evaluated on the next sample. For results to be valid, there should be consistency between the in-sample and out-of-sample results. When results are consistent and indicate an edge, the strategy is then evaluated with paper trading and finally with live trading.

As much as possible, choose your sample periods so that both the in-sample and out-of-sample data covers a variety of market conditions. Most backtests have an element of survivorship bias built into them because delisted and suspended stocks are not included in the test data. Wherever possible you should try to include these stocks when using backtesting tools.

A good trading strategy is as much about risk management as it is about profits. It’s important to learn about the various risk management metrics. Strategies that tend to be robust and endure over time are often quite volatile. By contrast, strategies that have low volatility often break down when traded live. You should be prepared to accept some volatility if you want a strategy that continues to be profitable.

Choosing backtesting tools and software

Choosing Backtesting Tools / Software
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There is a wide variety of platforms available for backtesting. These are some of the considerations to look out for when choosing a platform to evaluate your strategy:

  • Markets – Different platforms cover different markets. Typically a platform will include one or more of the following groups of stocks: US listed, Canada, US OTC, European and other international.
  • Time period – If you are developing long term or timeless strategies, you should be able to test them over longer periods of time. Some platforms have data going back decades, while others only have 5 to 10 years of historical data.
  • Price action data, fundamental data, or both? – You may be building trading strategies based on technical analysis / price action or you may be building investment strategies based on fundamental data. You may also be using a combination of both. This is an area where trading and backtesting tools vary a lot. Some only use price and volume data, while others have a focus on filters like growth and valuation metrics. You will need to find out exactly which data the platform includes, and which of these filters can be used in a backtest.
  • How sophisticated can a strategy be? – Following on from the previous point, there is also a considerable difference between different platforms when it comes to building a strategy. Some stock screeners allow you to evaluate the profitability of a set of filters, while others allow for full strategy creation. Backtesting a set of filters can be informative for long term investors, but has its limitations. To evaluate a proper trading strategy, you need full control of entry and exit criteria. Each platform differs with regards to how sophisticated a strategy can be – and it really depends how simple or complex you want the system to be.

Best backtesting tools and software

Investor / Tablet
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TD Ameritrade and NinjaTrader mentioned above both include backtesting tools. Some of the other backtesting platforms we like include:

TrendSpider

TrendSpider
TrendSpider

TrendSpider is one of the newer technical analysis platforms and offers some innovative tools that aren’t available elsewhere. The platform has also built a loyal community of users. The platform includes powerful backtesting capabilities along with its stock scanner.

When it comes to backtesting tools, TrendSpider offers two major advantages. Firstly, most of the platforms unique tools, including automated pattern recognition, can be incorporated in the strategies you evaluate. And secondly, creating strategies is easy and intuitive and does not require you to write code – though you can do that as well.

TrendSpider is primarily focused on price action rather than fundamental analysis. However it is still very popular amongst investors who focus on momentum and growth stocks. TrendSpider’s pricing ranges from $33 to $97 a month. The backtesting feature is included in the Elite plan with a $65 monthly fee.

TradingView

TradingView
TradingView

TradingView is another popular technical analysis platform with a large community of traders and investors who share their ideas and strategies on the platform. The platform is cloud based and includes all of the technical analysis features you would expect to find on a TA platform. One of the major advantages of TradingView is that most global stocks and other assets are covered.

TradingView’s backtesting is not the most advanced around – but it is easy to use. It also displays results in an easy-to-understand visual format. Creating strategies on TradingView requires coding in the native programming language, Pine Script. This may sound complicated, but its actually quite easy to copy and adapt strategies shared by other traders. TradingView pricing ranges from free to $59.95 a month. The backtesting tool is available on the free tier, so you can try it out for free.

Trade Ideas

Trade Ideas
Trade Ideas

Trade ideas is an advanced market intelligence platform that leans heavily on artificial intelligence. The platform includes numerous AI powered algorithms that generate trade ideas and can be incorporated in a strategy. Trade Ideas also includes social data that is built into the algorithms.

The backtesting tools module is very intuitive and does not require coding knowledge. It also provides very informative analysis of results and suggestions for optimizing a strategy. Trade Ideas has two subscription tiers of $118/month and $228/month. The backtesting tools module is included in the more expensive tier.

FinViz

FINVIZ Review
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FinViz is primarily a stock scanner to filter stocks using a combination of descriptive, technical and fundamental criteria. In total there are 70 criteria you can use to narrow the market down to a more manageable watchlist. FinViz is also packed with other useful tools to help you keep on top of the stock market.

The FinViz backtesting tools module is fairly basic and only includes price action indicators, rather than the fundamental and descriptive filters. However, it can be a useful tool to develop trading strategies for stocks you find using the screener. FinViz offers a good balance between being straightforward to use and still be very informative and useful. The backtesting module is included in FinViz Elite which is available for $39.50/month. You can learn more in our extensive FinViz review.

QuantConnect

QuantConnect
QuantConnect

QuantConnect is one of a new breed of platforms for quantitative and algorithmic traders. It is cloud based and open source with an emphasis on collaboration. This platform includes fundamental data as well as price and volume data. The platform can also be used to trade automatically.

Building strategies, backtesting and trading with QuantConnect requires you to write code in Python or C++. The learning curve is steep and requires commitment. However, if you want to develop and assess strategies based on both fundamental and price data, QuantConnect is the way to go. Pricing starts at $8 for individual users – however some data feeds incur additional charges.

Conclusion: Stock market simulators and backtesting tools

Both paper trading and backtesting are a crucial part of the trading process for beginners and experienced traders alike. In fact, testing your strategy and skill before going live can be the difference between taking educated risks and gambling. By using a stock market simulator and backtesting tools, you can ensure that you really have edge before you put precious capital on the line. What are your favorite paper trading and backtesting tools?

About Richard Bowman
Richard is partner at InvestOpen, analyst and investor based in Cape Town, South Africa. He has over 18 years’ experience in asset management, financial media and systematic trading. Richard combines fundamental, quantitative and technical analysis with a dash of common sense.

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