August 26, 2014. Most private investors have, at one time or another, run a virtual or “paper” portfolio. These undoubtedly have value in that you can learn to trade hypothetically.
This enables you to learn the ropes of investing, evaluating the worth of different companies and the extent to which the market may be pricing in too much optimism or too much pessimism. Being strict with yourself over what trades you’ve placed, taking full account of spreads and dealing costs, can be a sobering reminder of what a tough game this is. On the other hand, if you pick the right moment of maximum pessimism when the market is at or near its absolute nadir – the complete opposite can be true and you can’t believe how easy it is to make virtual money investing in the market. But as Kipling said – you need to try and treat these two impostors just the same – i.e. extreme good or bad fortune. Each is very dangerous in its own right.
It’s been said that a rising market lifts all boats, but also that when the tide recedes, you really get to see who’s not wearing a bathing costume! In a rising market such as that which happened with the tech and internet-based stocks at the end of 1999 and early 2000, when such small stocks were known to double in day, many so-called “investors” were acting as if the market was one big online casino. Had you been running a paper portfolio at the time, you may well have been kicking yourself that you were losing out on the opportunity cost of making thousands of dollars.
In many ways, stock markets are akin to the gambling world. In a casino, though, the house edge means the market is slightly stacked against you (unless you’re able to take advantage of generous introductory bonuses that is). Perhaps a poker tournament is a better analogy in that having a solid strategy can pay off as it does with investing. But gambling is generally a zero-sum game, whereby players’ gains are balanced by others’ losses. With stock markets, overall growth is possible as companies prosper and investors gain dividends. But thinking like a shrewd gambler is still a good way to approach markets – particularly in being risk-averse.
So, for example, if you’re a feet-on-the-ground type of investor looking in detail at balance sheets, real earnings, dividends and future prospects – you would have been stuffing your pockets with the shares of old economy stocks that were right out of favour in late 99 and early 2000. These were the sort of companies that would have you well covered with a bathing suit when the tide went out.
The trouble with dealing with hypotheses, though, is that they’re no real substitute for putting our real money where your mouth is. This is whole different ball-game from running a virtual portfolio. No matter how hard you try to, you can’t really force yourself to accept that the paper portfolio is real and to act accordingly. So that isn’t to say a virtual portfolio is useless. But it’s a dangerous way of giving yourself too much misplaced confidence.
In the real “heat of battle” on a day when the market has lost as much as ten per cent in a single day, and everyone is calling it down further yet - it’s a lot easier to buy stocks on paper than it is with your own real cash. So try a virtual portfolio – but always accept it for what it really is.
Image - Creative Commons - by StÃ©fan