Worried about making an investment mistake? Do this first

 

We’ve all felt it before – that uneasy feeling after we get confirmation from our online broker that our buy order just went through.

Did I make the right decision? Is this trade going to make me money? Did I just make a mistake?

These questions are totally normal. After all, we’re hardwired to fear loss.

But they stem from one common problem all investors face at some point – the lack of conviction in your decision-making process.

Whether you’re a day trader, a buy-and-forget speculator or a research-driven investor, a lack of conviction can lead to losses and missed opportunities.

But there’s a way to overcome the confidence problem – without risking your capital.

Paper trading is your driving range

Imagine you want to learn how to play golf. Do you buy a full set of clubs and head straight to the tee? Of course not.

You buy (or even possibly borrow) one club – usually a seven iron – and go to a driving range with a good coach. You spend hours swinging at nothing – just practicing the correct stance, backhand swing, angle, foot positioning and follow through.

Then you spend countless hours hitting the ball and ultimately perfecting your swing. You do this for every type of club until you’ve taught your body to master the swing and distance.

Then you head on to the tee, confident that you won’t make a wild swing that ends up hurting somebody or be the guy who dropped five bogeys at each hole.

Well, there’s a driving range for investors. It’s called paper trading.

Put simply, paper trading is trading stocks using pretend (or imaginary) money.

When you find a stock that you consider a potential investment, you pretend that you invested a certain amount of money to buy a certain number of shares. Then you wait to see if your decision was right.

Paper trading used to be done by simply taking note of imaginary transactions on paper. But with computers and smartphones, you can actually paper trade stocks through trading programmes that give the exact look and feel of a real stock market.

Programmes like the one shown below show real-time data like you’d see from an actual online trading account. The only difference is that you’re not using real money.

Source: WarriorTrading.com

Three key benefits to paper trading

Mistakes don’t cost you money. When you’re just starting out (or even when you’re not), investing feels risky. The last thing you want is to end up in a hole before you’ve had a chance to get your feet wet in the market. With paper trading, you can make all the mistakes in the world and it won’t cost you a cent.

It allows you to thoroughly test your trading system. Whether your system is based on fundamental analysis, technical indicators or a combination of both, paper trading allows you to apply that system to an unlimited number of trades and scenarios. This would be impossible to do in a real-world setting, where you are limited by the amount of your investable capital.

Builds your confidence. Assuming your paper trades yield positive results, you’ll become more confident in your decision-making. It reduces the likelihood of second-guessing your decisions later. On the other hand, if your paper trades yield negative results, you’ll know better than to use your system.

However, it’s important to keep in mind the shortcomings of paper trading. These include the lack of real-world costs, such as brokerage commissions, taxes and other transaction fees.

The biggest shortcoming of paper trading – and one that will never go away – is the absence of the emotional factor that would normally accompany investments. If you have no money on the line, it’s much easier to be completely objective about your investment decisions. (The other shortcoming, of course, is that you don’t make money on winning trades!)

No matter how many times you’ve tested your system with paper trades, you should expect emotions to come into play the moment you put real money at stake. This is where discipline and confidence in your decision-making plays a big role. The most successful investors don’t let emotions get in the way of their investment decisions.

So even if you’ve been paper trading your system for a long time and think you’re ready for the real thing, it’s always a good idea to start with small investments. You can always build up the size of your positions as you get more comfortable with your system.

Good investing,

Brian Tycangco
Edtior, Stansberry Pacific Research

 

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