What is paper trading?
Paper trading is trading without investing any money. As a new entrant to stock trading then paper trading is the best way to test your skills and the chances of winning trades from your predictions. If you want to test a new trading plan developed by you, then paper trading is the best to test your plan and see if it gives you the profits according to that plan. Professional traders know about this and they never venture into new territory, or implement new trading plans without checking their efficacy. For doing all this paper trading is the best way to do. Paper trading is simulated trading where you can practise trading. In a live market you cannot practise by buying and selling shares in the stock market.

If you are a new investor, after creating your trading plan, you can buy and sell as per your plan for the next one month and see if your plan is working as expected and giving you the estimated returns. If it does not work then you can analyse your trades and make suitable changes to your plan. In this manner you can try out your plans and practise trading without losing any money. To earn steady returns from stock trading a stock trader needs a trading plan. There is no standard trading plan which can be used by all. Each trader will have a different approach to trading and plans that are suitable to his method of trading. A stock trader needs to work on this to create a trading plan that is suitable to him, gives him steady returns and is sustainable over a period of time. It needs a lot of home work. Most traders identify shares and study their past price trends. Based on the trends they work out and back test different trading plans. They identify out of that the best ones. The plan that gives them the maximum returns. Thereafter they will do paper trading to test.

The market trends never remain the same. They keep changing.
1. A Bull market trend - market is rising
2. A Bear market trend - market is falling
3. A flat trend - where the market moves within a band - prices are range bound

What I realised is, one single plan doesn't work for all these three conditions. We have to have three different plans for each of them.

In paper trading you create a trading sheet where you record all your purchases and sales. You do not buy and sell in the market with real money but record your transactions in the trading sheet for the buy orders and sell orders. These orders will be strictly as per your trading plan. Ensure that you have a trading plan before you do paper trading. Don't go in for short cuts. The market is merciless and the statistics say 98% of the new entrants leave the markets after wiping out their capital. So don't follow short cuts and be one among the 98%. Strive to be one among the 2% who are successful and carry on stock trading just like any other business activity. For more information on trading plans Download a trading plan

If you are an experienced trader who wants to try out new trading plans, then you can create several different positions simultaneously to compare the performance and payoff characteristics between multiple strategies. A textbook may state that writing a covered call is synthetically the same as writing a naked put, but in practice there are subtle differences. With a paper trading account, an investor can set up a bull credit spread and a bull debit spread simultaneously and watch how the payoff for each position changes as the market moves.

In a nutshell - Paper trading is a good way to learn the ropes without risking any money. You can do it simply by pretending to buy and sell stock, bonds, commodities and mutual funds and keeping notes of paper profits or losses. A guide for writing a trading plan