Pretend stock trading a perfect practice for the real world

Years ago I used to fly airplanes. Later, as an aeronautical engineer, I also designed them. Let me tell you, the two aren't the same.

Even if you know how to compute G-forces, it won't help you pilot an airplane. Once the plane goes into a spin, only training and experience count.

Sure, a scientific background helps you understand the numbers on the instrument panel. But the ability to act on them (or to refrain from acting) has little to do with math, and a lot to do with you.

It's the same with investments. Being an analyst is as different from being a money manager as an engineer is different from a pilot. The best analysis won't help you invest profitably unless you first learn to handle your own reactions to market G-forces.

Until flight simulators came along, book-smart pilots who overestimated their practical ability to handle rough weather often paid dearly. Today, per contra, even pilot-trainees can "fly" a simulator into a storm, to train for a real emergency.

Not that a flight simulator is ever a true substitute for a plane -- it won't let you feel the buffeting wind or the crushing G-forces; but it can show you the consequences of foolish actions without getting you killed.

Up to a few years ago, this was an advantage pilots had over investors. Investment management was taught mainly as theory, culminating with the money-pilot being thrown into the market's tempest and left to soar or crash.

What of simulated money management? There wasn't any; although, to be fair, several old-time investors always ran "paper portfolios" where they tried out ideas first. How? You start with a fictitious lump sum, "buy" and "sell" your stock picks in real time, keep track of the "gains" or "losses," and once in a while you review your "record" and draw real conclusions about what worked for you, what didn't, and why. What you learn about yourself often improves your real investment performance significantly.

And before you programming wizards e-mail me that this is the same as "back-testing," let me tell you that it isn't. In fact, it's really "forward testing," or even "self-testing," because not only your investment strategy is tested here, but your own reactions are, too -- just as a flight simulator tests both a pilot's ability to prepare a good flight plan and his or her reactions in real time.

Does paper trading really teach you to invest better? Believe me, it does. Years ago I used to do quite a bit of it, and the lessons stick in my mind to this day. It's one thing to be told that 90 per cent of all options expire worthless, and quite another to see all your "paper-traded" options end losers.

Or to read that momentum investing is a loser's game, versus seeing its devastating effect on your "paper portfolio." Why don't more investment students "paper-trade" for practice?

In principle it is simple and it costs nothing.

But in reality, keeping buy/sell records is a bore, even if you are using a spreadsheet, or even Quicken, so most get discouraged and stop. However, help has arrived: A free website called investopedia.com now lets you trade with fictitious money and see the results on a continuing basis. You start with a $100,000 (or a million, if you want, either in either U.S. or Canadian dollars, or both), and buy, sell, or sell short on-line.

You "pay" commission, "earn" interest on cash, "pay interest" on margin -- all done for you -- and watch how your paper portfolio "performs." You can even compete against others, if that's what you like.

But most importantly, you can note down why you made each trade, then go back periodically and see what works for you, and what you should avoid. I am willing to bet that even after a few months of this, your real investment performance will markedly improve, as you stop doing silly things, and do more wise ones. It will also teach you how to run higher amounts of money, without losing a single real penny -- just as a simulator can teach pilots to fly bigger planes, without running the risk of a crash.

One more thing: Not only is this website a good training ground for seasoned investors, it is also an excellent tool for teaching youngsters how to invest, because it has extensive help menus and dictionaries of market terms. Much better than playing Mortal Kombat (but be warned -- it can be more addictive too.) And speaking of keeping track: Next time I'll outline the record of all stock picks (and pans) made by money managers I have interviewed here, as well as by yours truly.

Until then, happy holidays to one and all.

Avner Mandelman is president and chief investment officer of Giraffe Capital Corp., a Toronto-based money management firm.

amandelman@giraffecapital.com