Editor's note: This week, in place of our normal commentary, we've gathered some of our top timeless trading lessons. These are the lessons we wish we'd had before we started trading... lessons many of us learned "the hard way." Whether you're already an experienced trader... or a novice just beginning to put money in the market... you'll find this series incredibly useful.
Monday, December 23, 2013
Read "how to trade" books for more than a few months, and you're bound to come across this terrible advice: Before you get started with "real" money, you should "paper trade."
Paper trading is when you trade but don't actually trade. It's "pretend" trading.
And in my opinion, it's a worthless activity.
Paper trading is when you imagine you've bought, say, 100 shares of your favorite stock. You might write down all the important trading information, the number of shares "purchased," the date, and the buy price... After the trade is over, you might even write down how much "money" you made or lost.
I know many people are getting into trading for the first time in their lives right now. They're tired of handing money to their broker or financial advisor, only to see it disappear like it did during the Nasdaq bust, the real estate bust, or the credit crisis. I don't blame them for wanting to learn how to trade...
But paper trading is an ineffective way to go about it. You see, money decisions – from buying a mutual fund to selling a stock to buying a television – are emotional.
Becoming a good trader isn't just about learning how to read charts or buying cheap assets. It's about suppressing the desire to "make it all" on one big trade... learning how to take small losses... and learning when it's time to simply sit out of the game for a while.
Paper trading doesn't get you any "live fire" training on overcoming your emotions. It's like trying to learn how to hit a baseball by swinging an imaginary bat. So what's the new trader to do?
Try "trading small."
If you have $30,000 to manage, take $3,000 or $6,000 and trade with it for a few years. This "beginner period" is when you will be as bad a trader as you'll ever be... so make your trading tuition as cheap as possible.
Trading just a small amount of money will bring your emotions out "to play." They'll do their best to torpedo your trading plans. They'll produce awful advice like, "I'll wait a while... It'll come back" or, "I'll just turn this trade into an investment."
I don't know about most people, but even if I have $1,000 in a trade, I stand up and take notice. I know I worked hard for that money. Emotions are stirred up. I manage them.
After you become comfortable taking small losses... after you get used to trading positions of just 1%, 2%, or 5% of your total capital... after you put together a track record of large wins and small losses, then you can consider allocating more of your wealth to your trading account.
You'll never learn to do those things without trading real money. Even a small amount will do.
Brian says another piece of terrible advice traders follow is factoring in Wall Street's ratings when buying stocks. "It's one of the surest paths in the world to wrecking your portfolio," he writes. There are two main reasons Wall Street's research is unreliable. Get all the details here: Why Your Broker Knowingly Gets You Into Losing Trades.
Starting small is just one of Steve Sjuggerud's basics of successful investing. "Follow these rules," Steve writes, "and you should be successful." Find all nine of Steve's helpful tips for beginners and seasoned investors here.
Consumer-discretionary stocks (XLY) is the best-performing sector in 2013... up about 40%.
Natural gas companies Cheniere Energy and Chicago Bridge & Iron both soar 75%-plus over the past year.
Japan's yen is the worst-performing major currency... down 17% in 2013.
Private-equity companies hit the jackpot this year... Blackstone Group and Fortress Investment Group rocket 90%-plus in 2013.