If you want to learn about trading stocks, a stock market simulator is a great place to start. But how do you know when you’re ready to move on to the real thing, and start putting your own money at risk?
Here are a few pointers to help you figure out when you’re ready to jump into the REAL stock market:
It’s Not About Results
Who’s in a better position to start investing for real: someone who made a million dollars in a stock market simulator, or someone who lost most of their virtual money?
The answer is more complicated than you might think. If you’ve been very successful in the simulator, it could mean one of three things:
1. You’re the next Warren Buffett.
2. You followed a high-risk strategy that worked this time, but may not always work in future.
3. You got lucky.
Keep in mind that investing is a long-term game. Success doesn’t depends on having a good month or even a good year, but on having a strategy that will be successful in most years and most market conditions for the next few decades. Unless you’ve been playing the simulator for years, your results are short term, and are no guarantee of future performance.
Market conditions also vary widely. The stock market has been doing well over the past few years. If you’ve been making money, that’s great, but will you continue to make money – or at least not lose too much – in a downturn?
Now let’s consider the person who lost money in the simulator. If you made a 50% loss when other players were making virtual fortunes, you might be thinking you’re not cut out for investing. You might be wrong.
Some of the best investors in history have made mistakes and learned from them. Buffett missed out on big gains on his first ever stock pick by selling too early. He learned the value of patient investing, which became a hallmark of his approach.
The key is to understand why you lost money, and what you would do differently next time. If you’ve learned from your mistakes, you’re in a better position than someone who’s made money without really understanding why. You now have three things that will help you as an investor: knowledge, experience, and a dose of humility.
Tools of the Trade
The point of the simulator is to learn. So what should you have learned, exactly, before you start investing for real?
Let’s start by taking a look at the most successful investors in history, people like Ben Graham, George Soros and Peter Lynch. Many of them pursued different investing strategies, but one thing they all had in common was a super-strong grasp of the fundamentals of evaluating a business.
That, after all, is what stock-market investing boils down to: trying to spot a company whose current value doesn’t fully reflect its future prospects. No matter which investing strategy you choose, you have to be able to read a company’s annual report and financial statements and understand exactly what every line means. So it’s best to know how to do your own research, thoroughly and diligently.
Beyond evaluating a business, you should also have some understanding of the bigger economic picture. You don’t have to be an economics PhD, but it’s helpful to have some understanding of the main economic indicators and how they affect the stock market, as well as the impact of interest rates and inflation.
And finally, investing in the stock market is all about risk and reward. You’re constantly evaluating how much risk you can afford to take on, and whether the reward on offer is worth it. Again, you don’t need to get deep into things like VaR and stochastic volatility, but you should have some understanding of what risks you’re taking on by investing in the stock market, and your own risk tolerance.
Your Life Situation
One more thing to take into account before you start investing is your own life situation. Investing in the stock market is a good way to get rich in the long term, but a lousy way to get rich quick. Even if you have all the skills you need to be a successful investor, you could still lose money in the short term through no fault of your own.
You should only start investing in the stock market when you’re making enough money to cover your expenses and pay down debt, and have enough savings to cover a few months of expenses at least.
Keep that emergency fund stashed somewhere safe, like a bank savings account, and only put surplus money – your long-term savings – into the stock market. Even then, it’s generally a good idea to have a mix of different investments, like bonds and overseas stock funds, so that you’re well diversified.
Now that you’re investing for real, you need to view your stocks as part of an overall portfolio of investments. Weigh up the risks, and decide how much of a stake you’re comfortable with.
To learn more about how stocks fit in with other asset classes in an overall investment portfolio, take our series of five courses on Building a Portfolio.