Learning how to buy stocks online can be a useful exercise for some beginning investors. But it can lead to you to big losses instead of profits

Do you know how to buy stocks online so that you make better returns on your portfolio—and avoid big losses? Some investors are nervous about trading stocks online and, in particular, which stocks to buy. So, instead of jumping right in, they start off by using the “practice accounts” or “demo accounts” that the online brokerage industry initiated.

Practice accounts are supposed to be identical to real accounts in all but one respect: you buy stocks in them with imaginary or “play” money, rather than the real thing. The brokerage industry says this gives would-be traders a free opportunity to learn how to trade online without risking any money.

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By using an online broker’s practice account, you can learn online trading essentials, such as how to enter an order to sell or buy stocks; how to double-check your order before submitting it, so you avoid obvious but common mistakes, like buying 10,000 shares when you only meant to buy 1,000; and so on.

However, the big risk with practice accounts is that you’ll try out a risky and ultimately unwinnable investment approach, like day trading or options trading, and hit a lucky streak. Learning the mechanics of how to buy stocks online can be useful—but also unexpectedly risky when your results from those unwinnable strategies are about to regress to the mean. This will deliver losses instead of profits.

 Using practice accounts doesn’t really teach you how to invest

 Public-relations efforts on practice accounts often refer to them as good places to learn about day trading and options trading, which are big money earners for online brokers. Most non-professionals who get involved with day trading or options trading wind up losing money if they stick with it long enough. In that respect, they are a lot like casino games.

Practice-account users aren’t learning how to invest. They are just learning how to enter orders to buy stocks online. Rather than an educational experience, practice accounts are a little like play-money sessions at Las Vegas, where gambling novices can learn to play casino games without risking any real cash.

In the casino, players are learning how to play the game. But they aren’t learning how to win, because that’s not possible. In the end, they can’t overcome the statistical advantage built into casino games that gives the house an edge. They’re really learning how to avoid losing their money any quicker than they choose to.

How to buy stocks online: Using automated stock-picking systems can backfire on you

Some investors who are learning how to buy stocks online use automated stock-picking systems to help them make investment decisions. These systems are typically marketed with impressive-looking performance records designed to make investors think they are sure to make guaranteed profits. However, those records are typically derived by “back-testing” the program against past data. In other words, the promoters go back through old trading records and see what would have worked in the past.

Automated stock-picking systems essentially do two things: First, they narrow down the data you use when you make investment decisions. Second, they apply a fixed rule, or rules, to draw a conclusion or an investment decision from that selection of data.

Unfortunately, the market’s key concerns continually change. Today’s good investments can turn into tomorrow’s dead ends. For a time, these systems seem to work, but that’s usually coincidental. If the market is going up and the system tells you to buy volatile investments, it automatically generates profitable trades. But they can just as quickly turn around and begin pumping out unprofitable trades. Often this happens just when they can do the most damage to the investor relying on the system.

How to buy stocks online: Develop a strong investment strategy and build a “buy and watch closely” portfolio with our Successful Investor approach

Of course, there are a variety of ways to build an investment portfolio. Some work better than others. But our buy and watch closely approach has done well for our portfolio management clients over the past few decades. We recommend this approach for our readers as well.

We start by applying our three-part Successful Investor rule for portfolio construction:

1. Invest mainly in high-quality, well-established companies, with a history of earnings if not dividends;
2. Diversify across most if not all of the five main economic sectors (Manufacturing & Industry; Resources & Commodities; Consumer; Finance; Utilities);
3. Downplay or stay out of stocks that are in the broker/media limelight. This limelight raises investor expectations to dangerous levels. When stocks fail to live up to those heightened expectations, share-price slumps can be swift and brutal.

Meanwhile, we advise selling particular stocks when we feel the situation has changed and they no longer qualify as high-quality investments. We also sell if we decide that a stock isn’t as high-quality or well-established as it needs to be, to cope with the challenges it faces. Of course, many of our sales are due to a successful takeover of a company’s stock, which generally results in a major profit for our clients.

Have you learned and practiced how to buy stocks online? What has your experience been buying stocks online?