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Topic: How To Invest

Investor Toolkit: How “practice accounts” can tempt you into risky investing habits

Time vs Money

Every Wednesday, we publish our “Investor Toolkit” series on TSI Network. Whether you’re a new or experienced investor, these weekly updates are designed to give you advice on how to trade stocks and other investment topics that will help you develop a successful approach to investing. Each Investor Toolkit update gives you a fundamental tip and shows you how you can put it into practice right away.

Today’s tip: “Practice accounts are advertised as a good way to learn how to invest, but they can encourage investors to develop bad habits.”

The online brokerage industry is winning a lot of attention and goodwill for itself by offering “practice accounts”. These accounts are supposed to be identical to real accounts in all but one respect: you trade 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.

I’d say that’s a misstatement—a classic 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.

Practice-account users aren’t learning how to invest. They are just learning how to enter orders 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, you are learning how to play the game. But you aren’t learning how to win the game, because that’s not possible. In the end, players can’t overcome the statistical advantage built into casino games that gives the house an edge. You are learning how to avoid losing your money any quicker than you choose to, and how to avoid making a spectacle of yourself in the process.

How Successful Investors Get RICH

Learn everything you need to know in 'The Canadian Guide on How to Invest in Stocks Successfully' for FREE from The Successful Investor.

How to Invest In Stocks Guide: Find 10 factors that make your investments safer and stronger.

 I consent to receiving information from The Successful Investor via email. I understand I can unsubscribe from these updates at any time.

How a lucky streak could lead to big risks

Using an online broker’s practice account, you can learn online trading essentials, such as how to enter a buy order or a sell order; 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.

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.

COMMENTS PLEASE—Share your investment experience and opinions with fellow TSINetwork.ca members

Have you ever used a brokers’ online practice account? What did you learn from it? Did it make you a more successful investor in any way? Let us know what you think.

Comments

  • Darren 

    Totally agree with your article on Practice Accounts.

    In the late 90’s (dot com boom) I opened a yahoo practice account and picked some stocks. I looked like a genius as the market rose. Started to think that I was a good stock picker.

    When the bubble popped, I lost thousands of (thankfully fake) dollars, and learned a valuable lesson.

    Practice Accounts are not always a good thing. This is the first time I’ve seen it in writing.

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