One of the first pieces of advice that is given to new traders is that it always makes the most sense to start trading with a demo account. While this approach has some clear advantages and allows you to become familiar with your trading station, general position strategy, and the Forex market itself -- there are some drawbacks as well. So, it makes sense to have an idea of where potential pitfalls lie because, at some stage, all traders will have to make the leap from virtual trading to the real thing. Here we will touch briefly on the benefits that are offered by virtual accounts and then compare those to some of the weaknesses and deficiencies that are created by these types of trades. It is important to understand the differences here, as this is the only way to insure that you are truly ready to start actively trading with real money.
Benefits of Demo Trading
Any trader that does not begin trading using a demo platform can (and probably will) suffer sizable losses in a short period of time. Forex markets have the tendency to see extreme changes in volatility during certain parts of the week (for example, when a critical piece of economic data is released), and for those opening leveraged trades, these moves can prove disastrous when they work out unfavorably. Demo trading allows us to get a better sense of the ebb and flow of market behavior and to position accordingly. Also, for those with automated Expert Advisor (EA) strategies, demo trading will allow you to test your strategy using real market conditions, in order to determine its efficacy.
Next, trading with a demo account will allow you to familiarize yourself with all aspects of your platform without risking material mistakes. With all of the software platforms available now, it is important that traders understand how exactly to go long or short on a pair, how to set stop losses and profit targets, how to attach indicators to your chart, and how to manage your open positions. Clicking the wrong button can cost real money without this knowledge, so it is important to have a firm understanding of your platform before going live.
Last, demo trading can allow you to monitor the effects of leveraged positioning. Trading accounts can see massive fluctuations in balance when leverage is used, and practicing with certain leverage ratios can help you protect your account down the road. Some brokers allow leverage of up to 500:1, so a trader that wants to take advantage of these offers should try a few trades with these excessive leverage levels with a practice account so they can see how quickly these position sizes can influence your account balance.
Limitations of Demo Trading
So while demo trading is highly valuable, there are many examples of individuals that hold onto their demo accounts longer than they should. And while the drawbacks here might not be readily apparent, they most certainly do exist. First, with demo trading it is impossible to develop a sense of the emotional reactions (fear vs. greed) that will be encountered when live positions are open and active. In order to be a successful trader, you will need to manage these emotions and make decisions in an objective and logical manner. In trading, fear is healthy because it means you are aware of what is at stake. Managing that fear in constructive ways is the real task, and it is impossible to learn to do this when demo trading. Demo trading gives the illusion that your positions will have no real monetary consequences, and this can create problems once you make the transition to a live account.
Next is that demo trading can create unrealistic expectations. It is easy to become over-confident when demo trading because it is much easier to simply wait for your positions to turn positive before closing them out. This is not something that can be done when trading live because your account size is finite (as opposed to the infinite account size you have when trading with virtual money). When using real money, there may come a time when unrealized losses are accumulating too quickly and your positions will need to be closed, either manually by you -- or through a margin call. Because of this, it can appear as though trading is much easier than it actually is, if all we have is experience with demo accounts.
Last, it is impossible to know how committed we truly are to a trading strategy if real money is not being put at risk. It can be easy to make the decision to open or close a position when demo trading, but this is not always the case for live accounts. If you are able to pull the trigger on a trade, it is a good indication that you have real confidence in the ability of your trading system to generate consistent profits. Once a position is open, many decisions will need to be made. Where will you place your stop loss and profit target? Will you move your stop loss if the trade moves in your favor? When will you move that stop loss and by how much? If the trade works against you, will you add to the position? Are there any circumstances where you will close out the trade, even if the stop loss or profit target has not been hit?
These are all questions you will need to be able to answer in order to trade with real money. And you will need to know how you will truly react once these situations present themselves. Unfortunately, demo trading will only give you a diluted sense of how you will really act in live environments. The only way to get a true idea of your likely strategy and behaviors will be to start getting active with a live account.
Conclusion: Demo Trading is Useful, But Gives Only a Limited Picture of Live Environments
Make no mistake, it is absolutely essential for new traders to get early practice with demo accounts. This should also be viewed as a requirement for those transitioning to trading software or a new brokerage company. Back testing results for those using EA will also need to run these tests using a virtual account. But once these preliminary lessons are learned, it is time to move on, or you run the risk of developing trading habits that are not useful. Moving into live trading will allow you to improve your trading discipline and cultivate behaviors that will lead to consistent profitability over time. Risk management skills become honed much more quickly when traders have a real stake in their positions, and this is something that cannot be truly achieved using a demo account. So, while virtual positions do have tremendous value, it is important to note the differences between these two environments, so that avoidable mistakes are not made down the line.
Benefits of Demo Trading
Any trader that does not begin trading using a demo platform can (and probably will) suffer sizable losses in a short period of time. Forex markets have the tendency to see extreme changes in volatility during certain parts of the week (for example, when a critical piece of economic data is released), and for those opening leveraged trades, these moves can prove disastrous when they work out unfavorably. Demo trading allows us to get a better sense of the ebb and flow of market behavior and to position accordingly. Also, for those with automated Expert Advisor (EA) strategies, demo trading will allow you to test your strategy using real market conditions, in order to determine its efficacy.
Next, trading with a demo account will allow you to familiarize yourself with all aspects of your platform without risking material mistakes. With all of the software platforms available now, it is important that traders understand how exactly to go long or short on a pair, how to set stop losses and profit targets, how to attach indicators to your chart, and how to manage your open positions. Clicking the wrong button can cost real money without this knowledge, so it is important to have a firm understanding of your platform before going live.
Last, demo trading can allow you to monitor the effects of leveraged positioning. Trading accounts can see massive fluctuations in balance when leverage is used, and practicing with certain leverage ratios can help you protect your account down the road. Some brokers allow leverage of up to 500:1, so a trader that wants to take advantage of these offers should try a few trades with these excessive leverage levels with a practice account so they can see how quickly these position sizes can influence your account balance.
Limitations of Demo Trading
So while demo trading is highly valuable, there are many examples of individuals that hold onto their demo accounts longer than they should. And while the drawbacks here might not be readily apparent, they most certainly do exist. First, with demo trading it is impossible to develop a sense of the emotional reactions (fear vs. greed) that will be encountered when live positions are open and active. In order to be a successful trader, you will need to manage these emotions and make decisions in an objective and logical manner. In trading, fear is healthy because it means you are aware of what is at stake. Managing that fear in constructive ways is the real task, and it is impossible to learn to do this when demo trading. Demo trading gives the illusion that your positions will have no real monetary consequences, and this can create problems once you make the transition to a live account.
Next is that demo trading can create unrealistic expectations. It is easy to become over-confident when demo trading because it is much easier to simply wait for your positions to turn positive before closing them out. This is not something that can be done when trading live because your account size is finite (as opposed to the infinite account size you have when trading with virtual money). When using real money, there may come a time when unrealized losses are accumulating too quickly and your positions will need to be closed, either manually by you -- or through a margin call. Because of this, it can appear as though trading is much easier than it actually is, if all we have is experience with demo accounts.
Last, it is impossible to know how committed we truly are to a trading strategy if real money is not being put at risk. It can be easy to make the decision to open or close a position when demo trading, but this is not always the case for live accounts. If you are able to pull the trigger on a trade, it is a good indication that you have real confidence in the ability of your trading system to generate consistent profits. Once a position is open, many decisions will need to be made. Where will you place your stop loss and profit target? Will you move your stop loss if the trade moves in your favor? When will you move that stop loss and by how much? If the trade works against you, will you add to the position? Are there any circumstances where you will close out the trade, even if the stop loss or profit target has not been hit?
These are all questions you will need to be able to answer in order to trade with real money. And you will need to know how you will truly react once these situations present themselves. Unfortunately, demo trading will only give you a diluted sense of how you will really act in live environments. The only way to get a true idea of your likely strategy and behaviors will be to start getting active with a live account.
Conclusion: Demo Trading is Useful, But Gives Only a Limited Picture of Live Environments
Make no mistake, it is absolutely essential for new traders to get early practice with demo accounts. This should also be viewed as a requirement for those transitioning to trading software or a new brokerage company. Back testing results for those using EA will also need to run these tests using a virtual account. But once these preliminary lessons are learned, it is time to move on, or you run the risk of developing trading habits that are not useful. Moving into live trading will allow you to improve your trading discipline and cultivate behaviors that will lead to consistent profitability over time. Risk management skills become honed much more quickly when traders have a real stake in their positions, and this is something that cannot be truly achieved using a demo account. So, while virtual positions do have tremendous value, it is important to note the differences between these two environments, so that avoidable mistakes are not made down the line.
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