Topic: How To Invest

The real costs of using practice accounts to buy stocks online

buy stocks online

Whether you’re a beginner or an experienced investor, these tips give you fundamental advice and show you how to put it to work right away–without any need for practice.

Today’s tip: “Practice accounts that let you buy stocks online without real money may seem to be a convenient way to learn investing. But they can lead investors to take an investment approach that puts their money at risk.”

The online brokerage industry has been getting a lot of attention and goodwill by offering “practice accounts.”

Practice accounts are supposed to be identical to real accounts in all but one respect: you buy stocks online in them with imaginary or “play” money rather than the real thing. The industry says this gives would-be traders a free opportunity to learn how to trade online without risking any money. That’s not the same as learning how to invest.

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To us, this appears to be a misstatement—an example of the essence of marketing, which is to describe a feature in such a way that the prospect comes to see it as a benefit.

Using practice accounts to buy stocks online can distract you from a long-term investment strategy

Practice-account users aren’t learning how to invest. They are just learning how to enter orders to buy stocks online. Rather than an educational experience, practice accounts are a little like play-money sessions at Las Vegas, where gambling novices can learn to play casino games without risking any real cash.

In the casino, players are learning how to play the game. But they aren’t learning how to win, because that’s not possible. In the end, they can’t overcome the statistical advantage built into casino games that gives the house an edge. They’re really learning how to avoid losing their money any quicker than they choose to.

Using an online broker’s practice account, you can learn online trading essentials, such as how to enter an order to sell or buy stocks online; how to double-check your order before submitting it, so you avoid obvious but common mistakes, like buying 10,000 shares when you only meant to buy 1,000; and so on. In doing so, you can choose what stocks to buy, but the only feedback you’ll get on your choices is the price changes they go through after you buy.

However, there is a large random element in short-term stock market results. It will take months or years before you know if your choices are likely to provide attractive long-term returns. In fact, the real test will come only when you see how you do in the next bear market.

Practice accounts encourage behaviour that benefits brokers

Public-relations efforts on practice accounts often refer to them as good places to learn about day trading and options trading, which are big money earners for online brokers. Most non-professionals who get involved with day trading or options trading wind up losing money if they stick with it long enough. In that respect, they are a lot like casino games.

The big risk with practice accounts is that you’ll try out a risky and ultimately unwinnable investment approach, like day trading or options trading, and hit a lucky streak. This could embolden you to put serious money at risk just when your results are about to regress to the mean and deliver losses instead of profits. We advise your to focus on selecting high quality stocks and holding them.

Note: This article was originally published in 2009 and is regularly updated.


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