For reasons I don’t understand, most people enter the stock market for the first time without practicing or testing. Perhaps they read articles and books or watch videos about the market. Should anyone get a driver’s license after viewing a “how to drive” video? Of course not. New drivers practice driving in a parking lot or deserted street before getting on the highway.
Unfortunately, as we’re seeing now with GameStop
and AMC Entertainment Holdings
many new traders and investors enter the market without practicing first. It’s not surprising that most rookies lose money — sometimes a lot of money — when starting out.
By practicing and testing before you trade or invest, two problems are solved. First, you become familiar with brokerage software. Second, the more you practice, the more skills and knowledge you gain.
Let’s discuss some of the ways to use a simulated or paper money program, and which brokerages allow you to practice before making a real trade.
Test before you buy
Before making a trade using real money, duplicate the trade in the paper money program. For example, if you wanted to buy 100 shares of Apple, before making that trade, buy 100 shares in the simulated trading program.
If your timing was wrong, which is a common problem, you will lose money in the paper money program. Maybe your entry was poor. Maybe you bought right before the stock reversed. No matter the reason, the more you test, the more your timing will improve.
Many people believe that “no one can time the market.” In reality, some traders can time the market. It’s not easy, and it takes a lot of practice, but getting the timing right is an important trading skill. Use the paper money program to develop that skill.
Fear of missing out (FOMO)
On the other hand, let’s say you bought Apple at the right time, and made money in the paper money program. In this example, you may consider buying in the real trading program. This is a “trend following” strategy.
If you are the type of trader or investor who hates to miss out on potential gains, then testing before buying might feel like you’re missing out. If you buy a fast-moving stock, you may believe you don’t have time to do a test trade.
Even with these limitations, if you are a beginner, I urge you to make dozens or more test trades before betting real money. How long do you practice trade? Everyone has a different learning curve. Some may need a few days; others may take months.
Be sure to paper trade with the same number of shares in the test program as in real life. For example, do not not pretend to buy 10,000 shares of Apple if all you can afford is 50 shares. Test trade with 50 shares.
For those who want to skip the simulated program and start trading immediately, there is an alternative: Buy between 1 and 10 shares of a stock you believe has potential. By trading small, you learn the brokerage software while also making or losing real money. This is a reasonable alternative for anyone not wanting to test trade first.
Experienced traders: Test strategies or take a break
Experienced traders often use simulated trading programs to test strategies. Let’s say you were interested in selling stocks short, a strategy not recommended for beginners. Before using real money, practice this risky strategy in the simulated program for as long as needed until you have gained experience and skills.
If you’re on a losing streak, practice in the simulated program until you get your confidence back. In addition, after practice trading, re-enter the market but with much smaller share size. For example, if you normally buy 1,000 shares and lost money, trade with 100 shares until you figure out what went wrong.
Listen to tips — but test first
I used to advise people not to listen to tips, but I’ve changed my mind. Feel free to listen, but test first. For example, if your neighbor or some tout on TV tells you to buy shares of a stock, test it out in a paper money program.
First, this allows you to evaluate whether the tipster is reliable. Second, you find out if the tip is valid. As long as you aren’t afflicted with FOMO, you can always buy the stock later.
Where to find simulated or paper money programs
These brokerage firms offer paper-money trading programs: TD Ameritrade, Interactive Brokers, TradeStation and E*TRADE . I am certain that nearly every brokerage firm will have a simulated trading program in the future. Why? Because customers will demand it.
In addition to the brokerage firms, MarketWatch has a simulated trading game through its “virtual stock exchange,” with a 15-minute quote delay and $100,000 in play money. Investopedia also allows you to set up a trading game with $1 million in play money and a 15-minute quote delay.
Currently the best simulated trading program is the paperMoney Virtual Stock Simulator on the thinkorswim platform from TD Ameritrade. You’re given an unlimited amount of paper money to use for 60 days free of charge (even if you don’t have an account with the firm). You can practice trade with this program at platform.thinkorswim.com.
So the next time you are thinking of buying a stock, test before you buy. Although not everyone is a fan of this method, the benefits far outweigh the negatives. Rushing into a trade without testing is a mistake you don’t have to make.
Michael Sincere is the author of “Understanding Options,” Understanding Stocks,” and the forthcoming “Make Money Trading Options.”