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Does Paper Trading of Securities Make Sense?
According to some people, paper trading
of securities is the best way to begin investing, whilst
others say it is a complete waste of time. So what should
you do? Let's take a look at why you would consider
paper trading.
Some people read books on trading and
investing, go to various seminars, paying hundreds or
sometimes even thousands of dollars to get educated,
but still don't get to the point where they actually
put in their trades. They like the idea of acquiring
knowledge, pondering investment strategies and thinking
about various trades they might like to make. However
somehow they just don't seem to do anything with the
knowledge they acquire. They don't put their investment
strategies into action and they never really make the
trades they are constantly thinking about.
Paper trading is a form of simulation
and therefore, like all simulations, it has certain
advantages:
- It offers great learning potential.
- There is no financial risk involved. You can't lose
money.
However, inherent in all forms of simulation
is also a number of disadvantages. For paper trading
disadvantages are:
- Unlike most other forms of simulation, there is no
real way to speed up the process. Of course you could
start with historical prices, but the whole exercise
tends to get a bit artificial that way.
- There are no financial benefits. You can't make money.
- There are no financial risks. You can't lose money.
- It just isn't real.
The first and second disadvantage seem
obvious. The third may appear strange at first, especially
since it was also listed as an advantage. Some of you
might wonder: "How can the absence of financial
risk ever be a disadvantage?". To answer that question
we just have to look at the fourth disadvantage, which
ties them all together. This last one really is the
big one. The lack of any true financial implications
seriously inhibits the learning effect. No matter how
much you think, speculate, simulate or however you would
like to call it, until you actually put your money where
your mouth is, it just isn't real. We tend to learn
most from our mistakes, especially mistakes that hurt.
If it doesn't hurt it just doesn't have the same effect.
It's like people watching a boxing match
on television claiming they would never give up if they
were up there. Statements like: "You can knock
me out, but you can't make me give up" are easy
to make. The truth is that most people making such a
statement have never experienced a situation even remotely
like it. If they would actually find themselves in that
ring, facing an opponent, most of their bravery would
vanish in less than an instant. As soon as they would
start to feel some of the pain that those fighters have
to endure, most would quickly sing to a different tune
and leave the ring.
"But that's physical pain. That's
different." you might say. Fact is that emotional
pain can be just as intense and even worse. Take someone
that has lost something dear to him; whether it is a
loved one, a relationship or his life's savings. Then
ask him the following question: "Knowing what you
know now, if you could do it over again and you could
choose between physical pain, in the form of a beating,
or losing whatever it is you lost, which would you choose?".
Most would opt for the beating without a second thought.
Doesn't make sense? Well maybe not, until something
like that happens to you or someone you know.
Which leads us back to the initial question:
"Does paper trading make sense?". When your
goal is to get some experience in using specific financial
products or derivatives, for example stocks, options
or futures, paper trading can be very helpful. However,
when you consider paper trading because you are essentially
afraid to get your feet wet, which is the main reason
for many people, you will be disappointed by the results.
No matter how many trades you have put in on paper,
all your paper confidence will quickly evaporate when
your hard earned money is on the line. The way you react
to the fear of losing real money is something you just
can't simulate.
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