Almost every book on stock trading will strongly suggest you begin with paper trading for a few months before you invest any real money into the project. There are great paper trading tools for almost all the major exchanges including the FOREX and CBOE, however the pink sheets are not nearly as official and there aren’t as many great paper trading tools in this market.

Here’s the great part about paper trading: It was originally called paper trading for a reason, because you can do it on paper. The most difficult part of fake investing, or practice trading, is the urge to cheat yourself. During this phase I suggest you have an accountability partner to make sure you “place your order” each day and to make sure you account accurately.

Keep in mind this practice trading will help you see how well you do without the risk of losing money. If you don’t keep accurate records you won’t get an accurate picture of how well or how poorly you would do in this market. This is a great way to learn without the risk of losing money, but only if you’re honest with yourself.

Setting up Your Paper Trade

Most people don’t have the ability to watch their stocks full time while they are paper trading, they need to be working to pay the bills. This is OK because you will get most of the return by just routinely doing your research, placing your trades, and closing out at the end of the day.

I prefer to set up a spread sheet with 3 or 4 different starting amounts. I like order of magnitude differences, maybe $2,000, $10,000, $50,000, and $100,000. You will just scale your trades appropriately for each starting amount so you can see if any of the amounts will leave you enough to live off of, or to provide you with the supplemental income you hope to achieve through trading. Then you need to choose your broker so you can use their trading commissions. This a good chance to see how different brokers treat penny stock traders.

Create Your Plan

You need to put a plan on paper and follow the plan until you write a different plan on paper. The big advantage to paper trading is seeing how you react to your plan, not to quantify your intuition (luck.) It’s OK to have a dynamic plan, it’s not OK to change your orders every morning by what you feel will work today.

Consider different strategies, then choose a stock trading strategy and stick to it. If you find that strategy doesn’t work for you try something else, but create a plan and stick to it.

Place Your Morning Trades

Every morning you want to place your trades. Just how you would normally trade penny stocks any other time, you should place your order, limit price, and exit price for the stock. When you return home at the end of the trading day record how you did. If you entered any trades attempt to see if there was enough volume to take your whole order or partial order, see if you reached your exit price. Since you are day trading you will close out your trades at the closing price if your exit price is not reached. Also apply any rules for exiting that were met if you can verify the conditions were met during the day.

Apply Fees

This is the least applied portion of paper trading. You can get away with ignoring them if you’re paper investing, but when paper day trading penny stocks the fees can make or break your returns. Apply the broker fees to every trade including any per share fee. Also apply the average spread of the stock to your cost since you’ll rarely get in or out for exactly what you intended. Also subtract out any money you require to live on if you are hoping to do this full time (either daily, weekly, or monthly) and don’t forget to pay your taxes. Now you’re seeing the real returns on your efforts.

Analyzing the Results

If you’ve done this honestly for a few months you’ve probably had some realizations. One is that the returns of penny stocks are very volatile. The second is if you didn’t have enough money you fell out of the game. The third is when you started with enough money the returns can get awesome. If your outcome was similar to what you expected and you feel comfortable enough in this market you may be ready to start trading penny stocks with real money.