It’s no secret that the stock market can be a risky place to invest.
But for some people, the temptation of potentially big profits is just too great to resist. And so they dive in, head first, without any real idea of what they’re doing. And as a result, they often end up losing a lot of money.
One of the biggest problems with this approach is that it’s very difficult to learn how to invest properly without actually investing any real money. This is where paper trading comes in – it’s a way for new investors to practise their skills without risking any actual money.
However, there are also some serious drawbacks to paper trading that you should be aware of. In this post, we’ll take a look at why paper trading can be terrible for practising stock investing/trading.
How Does Paper Trading Work?
Paper trading is basically a simulation of investing/trading, where you use pretend money to buy and sell stocks. It’s a great way to learn the ropes without risking any actual money.
There are a few different ways to do paper trading. You can use specialised paper trading software, or some brokerages offer paper trading accounts that mirror their real accounts.
One of the advantages of paper trading is that you can test out different strategies and see how they would have worked in the past. This can be a valuable learning experience.
However, there are also some major drawbacks to paper trading that you should be aware of…
The Drawbacks of Paper Trading
1. Paper Trading Gives You a False Sense of Security
When you’re paper trading, it’s very easy to get overconfident. After all, you’re not actually risking any real money, so what’s the worst that could happen?
The problem is that this false sense of security can lead to some bad habits. For example, you might take unnecessary risks or make impulsive decisions without thinking them through.
In the real world of investing, there’s no such thing as a free lunch. And so it’s important to remember that even though you’re not risking any actual money when paper trading, you could still end up losing a lot of money if you’re not careful.
2. Paper Trading Doesn’t Teach You How to Manage Your Emotions
Investing can be an emotional rollercoaster, even for the most experienced investors. And so it’s important to learn how to manage your emotions when investing.
However, paper trading doesn’t give you any experience of this. When you’re paper trading, it’s very easy to get caught up in the excitement of a winning trade or the anguish of a losing trade. But in the real world, it’s important to be able to keep your emotions in check.
If you can’t manage your emotions when paper trading, then it’s likely that you’ll struggle to do so when investing with real money.
3. Paper Trading Doesn’t Teach You How to Overcome Losses
No matter how experienced you are, there will always be times when you lose money when investing. And so it’s important to learn how to deal with these losses.
However, paper trading doesn’t give you any experience of this. When you’re paper trading and you make a loss, it’s very easy to just forget about it and move on. But in the real world, you need to be able to take these losses in your stride and continue to invest with confidence.
4. Paper Trading Can Give You a skewed View of Profits
When you’re paper trading, it’s very easy to focus on the profits that you’re making. And so you might get a skewed view of how much money you can actually make from investing.
In the real world, there will be times when you make good profits and times when you make losses. And so it’s important to have realistic expectations about the potential profits that you can make from investing.
5. Paper Trading Doesn’t Teach You How to Deal With Failure
No matter how successful you are as an investor, there will always be times when you fail. And so it’s important to learn how to deal with failure.
However, paper trading doesn’t give you any experience of this. When you’re paper trading and you make a loss, it’s very easy to just forget about it and move on. But in the real world, you need to be able to take these failures in your stride and continue to invest with confidence.
What To Do If You Are Paper Trading
Despite the drawbacks listed so far, there are still some benefits to paper trading.
Like learning how to swim, it’s not always the best idea to just jump into the deep end and start investing with real money. So if you’re completely brand new to investing and trading, or you’ve had a bad experience in the past, it’s probably a good idea to paper trade for a while first so that you can get a feel for how the markets work.
Replicate Your Financial Situation As Closely As Possible
The main caveat I would add is that you try to replicate your actual financial situation as closely as possible when paper trading – this means having a paper trading account that closely mimics how much capital you would actually have to invest, and using real-time market data rather than delayed data.
If you can do this, then paper trading can be a useful tool for learning how to trade and invest. Just remember that it’s not a perfect simulation of the real world, and so you need to be careful about taking everything you learn from paper trading too literally.
Don’t Paper Trade For More Than 1 Month
Another thing to keep in mind is to not stay in the trap of paper trading for too long.
Don’t stay in the mental trap of “not being ready yet.” You’ll never be ready just by paper trading alone. At some point, you will have to make that jump to get real, tangible results.
Paper trading can be a useful tool for learning how to trade and invest, but it’s not a perfect simulation of the real world. So you need to be careful about taking everything you learn from paper trading too literally.
I would suggest that you only paper trade for 1 month at most. During this time, focus on familiarising yourself with the switches and dials of your brokerage platform – this is what usually trips beginners up the most when they first start trading.
After 1 month, you should start investing with real money so that you can get started on building your real-world portfolio.
The Better Alternative: Start With A Small Account
If you’re serious about learning how to invest/trade, then the best way to do it is to start with a small account. This will allow you to get real-world experience of investing/trading without risking too much money. And it will also teach you the important lessons that you need to learn in order to be successful.
So if you’re just starting out, I would say paper trading is probably not the best way to go. Instead, you should ideally focus on building up a small account and learning from your real-world experiences.
➜ Related Post: Why You Should Start Investing Small (Even If You Have a Lot of Money!)
Conclusion
Paper trading can be a great way to learn about investing/trading without risking any actual money. However, there are also some serious drawbacks to paper trading that you should be aware of. In particular, paper trading can give you a false sense of security, skew your view of profits, and fail to teach you how to deal with real-world emotions and failures.
So if you’re just starting out, I would suggest that you focus on building up a small account and learning from your real-world experiences. This will be a much more effective way of learning how to invest/trade than paper trading ever could be.
Terry
