Definition
Paper trading
Paper trading runs a strategy against live market data with simulated capital. Definition, how it differs from backtesting, and what it cannot test.
Paper trading is running a strategy against live market data using simulated rather than real capital. Unlike a backtest, it operates forward in time on data the strategy has never seen, which removes the possibility of fitting to the outcome. Unlike live trading, no capital is at risk — and that is both its purpose and its central limitation.
- Also known as
- simulated trading · demo trading · forward testing
How it is calculated
Backtest → past data, instant, cheapest to run, easiest to fool yourself with
Paper → live data, real time, no capital at risk, no execution risk either
Live → live data, real capital, real fills, real behaviour
Paper trading tests the strategy. Only live trading tests the operator.
It closes the look-ahead gap that backtests cannot
A backtest can be tuned, consciously or otherwise, against data whose outcome is already known. Paper trading cannot: the next tick has not happened yet. Running a strategy forward on live data for a meaningful period is the cheapest available evidence that its edge exists outside the sample it was built on.
What it still does not test
Simulated fills do not compete for liquidity, so slippage and partial fills are modelled rather than experienced. More importantly, no simulation reproduces the behaviour of an operator watching real money fall. Paper trading validates the strategy; only live capital validates the person running it.
How it gets misread
Consistent paper profits are frequently taken as proof a strategy is ready. They establish that the rules produce signals with an edge under modelled execution — not that the fills are achievable at size, nor that the operator will follow the rules through the first real drawdown.
See also
Sources
- Interpretive Notice 9025 — Compliance Rule 2-29: Use of Promotional Material Containing Hypothetical Performance Results — National Futures Association
- Do Day Traders Rationally Learn About Their Ability? — Barber, Lee, Liu, Odean & Zhang, Haas School of Business, University of California, Berkeley
- Price Impact — J.-P. Bouchaud, arXiv (entry for the Encyclopedia of Quantitative Finance)
Definitions are educational. Nothing here is investment advice, and no metric described on this page predicts future results.
Definitions are the easy part
Knowing what drawdown means is not the same as having a system that halts on it. QANTERION applies these limits while a strategy runs.