trading (iii): start with a paper portfolio

practice first

As I mentioned last week, your initial plan may be very simple, no more than “I intend to beat the S&P 500 index by selecting sectors with superior profit growth potential,” or “I intend to beat the S&P 500 by selecting individual stocks that are deeply undervalued as measured by the price/cash flow ratio.”

The next step is to create a paper portfolio to test out your ideas.

The paper portfolio is just what the name implies:  you create a portfolio on paper of the names you would want to buy (or sell, if that’s what you think you’ll be good at), watch what happens and keep score.

Based on the results, you refine your ideas.

using real money…

…in small amounts.  That’s the next step.

My experience is that if a paper portfolio is like going to the batting cages to practice your swing, using real money is like playing in a game with a live pitcher and fielders.  Your concentration is sharper, because the stakes are higher.  Sometimes, people who have no trouble performing with a paper portfolio encounter difficulties with a real-money portfolio.  That typically passes with time.

On the other hand, unless you’re convinced that you’re not taking your paper portfolio seriously enough, real-money trading won’t go well if your paper portfolio has consistently underperformed.

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