Why Paper Trading Stocks May Not Make Sense

Many people, especially those who offer stock advice, say that paper trading of securities is the best way to begin investing. There are others who say paper trading is a waste of time. Who to believe?

There are many people who attend seminars, read books, subscribe to newsletters, and never put their new found knowledge to the test. They like the idea of being taught the techniques, but don't like the idea of actually making the trade. Somehow they just don't do anything with the lessons and knowledge they get from all their reading and attending.

If you think of paper trading as a simulation, it has advantages:

1) There is no financial risk involved
2) It's a great learning tool...hands on training

However, there are some disadvantages:

1) It isn't real so it lacks any connection to life
2) There is no way to speed up the process, very slow and boring
3) There is no financial incentive to do it
4) There is no financial risk

The first three disadvantages seem logical. When you look at disadvantage four, you think to yourself, isn't that an advantage? The answer is no and here's why. The first disadvantage is the biggest one. The absence of any truly financial implications inhibits the learning effect. No matter how much you speculate, or think about, or simulate the situation, unless and until you put the money of the table, it isn't real; it doesn't count. Humans learn from mistakes. We especially learn from mistakes that hurt either physically, mentally, or emotionally. When the mistakes don't involve any kind of hurt, it just doesn't matter. It doesn't have the same effect.

Think of paper trading as a baseball game. People in the stands are yelling to the batter to hit the ball. The fans scream at a player because he bobbles a ground ball. Comments like those are very easy to make when you are in the safety of the stands and not on the field. When you are at bat and facing a 96 mph fastball, it's a different story. Or, you're at third base, and a ground ball comes screaming at you and hits a small pebble and bounces strangely, try to catch that!

You may think that because the analogy to baseball is different because it's physical and not financial. Do you really believe that an emotional, financial loss is less than a physical loss? Ask someone who has just loss 50% of the money in his portfolio to compare that loss to having an arm broken, and see what they say. Emotional and financial losses are devastating.

This leads us to the question we asked earlier. Paper trading stocks - does it make sense? Yes it does when the purpose to paper trading is the experience of learning specific financial products or different techniques. Take for instance the in and out of stock options or the techniques of shorting stocks. If you haven't used these products or techniques, it makes sense to practice to learn how to use them. However, if you use paper trading because you are afraid to "put up or shut up", you are not helping yourself. No matter how many trades you put on paper, your confidence will quickly fade when your hard earned money is on the table and exposed to the whims of the market. The experience and learning of losing real money can not be simulated.