Topic: How To Invest

Practice stock trading accounts: A training tool or a distraction?

Model portfolios and practice stock trading have a lot in common. They both serve to distract investors from long-term investing goals.

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.

We’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.

Investors can be distracted from sound investing principles by model portfolios and practice stock trading accounts

Model portfolios and practice accounts have a lot in common. They both distract investors from long-term investing goals. Practice accounts and model portfolios don’t teach you anything about a long-term conservative strategy that meets our Successful Investor criteria. They instead focus your attention on making fast profits with quick stock market gains. Rather than an educational experience, practice accounts and model portfolios are a little like play-money sessions at Las Vegas, where gambling novices can learn to play casino games without risking any real cash.

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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 practice account can teach you 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. Model portfolios are marketed to only show you the gains you could make. In reality, 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.

Ideally, practice stock trading will teach you about these frequent investing mistakes

If you are unhappy with your investment results, you should check to see if you are making one or more of these four main investing mistakes:

  1. Buying and selling too often
  2. Buying too many low-quality investments
  3. Failing to diversify
  4. Buying too many stocks in the broker/media limelight

Well-established companies are the key to profitable and low risk investments

Instead of moving between extremes of risk, we continue to think Successful Investors will profit most—and with the least risk—by buying shares of well-established companies with strong business prospects and strong positions in healthy industries. That generally serves to highlight low risk investments.

Following that strategy doesn’t mean there won’t be surprises that affect every company in a particular industry. But well-established, safety-conscious stocks selected in line with our Successful Investor philosophy have the asset size and the financial clout—including sound balance sheets and strong cash flow—to weather market downturns or changing industry conditions.

Bonus Tip: Don’t let low commissions warp your investment decisions

Low commissions from discount brokers–and in some cases zero commissions–are better than high commissions, of course. But low or zero commissions can warp your investing decisions. You may decide that not paying high commissions gives you the freedom to sell at the first sign of trouble. However, all stocks go through troubled periods from time to time. High-quality stocks manage to overcome their troubles. Low-quality stocks go from bad to worse.

Some of your investments may be headed for a huge rise in the long term. If you always sell at the first hint of trouble, you can wind up selling your best stocks at a temporary low, just before a big rise.

What methods have you used to practice stock trading? Which have worked the best for you?

Have you ever used a practice stock trading account? What did you learn from the experience?


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