Forex Demo Accounts
Paper trading refers to the practice of trading in simulated environment without risking actual money. In the past this was done by keeping a paper trail of hypothetical trades hence then name. With the proliferation of online trading, paper trading has become as easy as opening up a free demo or virtual account and practising with virtual funds.
Demo trading has long been recognised as the entry point for all traders in the forex market, and has been likened to flight simulators for pilots as a first step in their process to becoming a pilot. There are many advantages and disadvantages about using a demo account which we discuss in detail below.
Advantages of Demo Accounts
For traders looking for a new broker, signing up for a demo account can be a quick and risk free method to test if the brokers trading platform fulfils the requirements you have before opening a real money account. For traders who have never used a trading platform to trade real money, the demo account provides a good base to kick start their trading career.
With the demo account, the trader gets an introduction into the practical world of real money trading without the risk of loosing real money. A demo account can be used to develop, test and optimise trading strategies and robots. From the performances seen on a demo account, the trader can improve their own trading strategies or expert advisors which will eventually be used to trade a real money account.
Trading is not just about placing entry and exit orders and collecting any profits made. Trading starts with getting to know the trading environment or the trading platform. To get the most out of a trading platform you have to study and use the platform to understand all the features, functions and shortcut keys that are used in the trading process. You also need to be familiar with charts, indicators and other trading analytical systems in the trade environment.
Using a demo platform is one way to get used to a trading platform without risking real money while you are just learning these basic features.
Disadvantages of Demo
Although a demo account can be a good option, there are several disadvantages of using a demo account one must consider. One of the major disadvantages about using a demo account is that it is not the real deal. The money used for trading is not real, the conditions are not real, and therefore the entire stage is detached from reality. There is no emotional roller coaster or surges of adrenalin a trader experiences when trading with real money.
There is also the issue of complacency in the usage of demo accounts. When a trader knows that money they worked and sweated for is not at stake, there will always be that complacency factor when using a demo account to practice trading. They may end up taking bigger risks and gambles they would otherwise not make in a real money environment skewing their actual results traders may experience.
Another disadvantage with demo accounts is that some of the elements of real money trading are missing. Traders may therefore not get to see the impact of factors such as slippage when trading and not experience some important factors that could impact their trading strategy.Demo accounts may therefore not be 100% reflective of a broker’s real money trading platform where one could experience, lag time, latency and other important factors that could differ when switching to their real trading platform.
Demo account alternatives
One option to overcome the major criticisms of demo accounts is to open a micro account, fund it with real money and use it to simulate real trading. Opening an account with a smaller deposit size will inherently lower the associated risk and is a good low cost method of getting introduced into the world of real money trading.
For instance, if you want to commence full-scale trading with $2,000, why would you open a demo account with a default amount of $100,000? There is no way you can practice essential skills like money management on such accounts.
But if you open a $100 micro account and use micro lots for trading, not only would you be trading under real market conditions, you will experience all the adrenaline rush and thrill of trading with real money. You will get to see how all the extraneous factors such as slippage, retracements, surprise news, etc., actually affect a trader’s psyche and trade outcomes.
Moreover, such a small account can easily be opened with money you can afford to lose. Many view the cost of opening a micro account as part of a traders learning expense.
Psychology of Trading
Trading is a mentally challenging event and a lot of it has to do with the psychology behind it.
When a trader makes winning trades, it can produce a feeling of exhilaration and ecstasy. When a losing streak hits, it can bring confusion and irrational behaviour on the part of the trader and common sense goes out the window, which in turn can lead to more bad decisions and opening more loosing trades.
It can be difficult, but it is essential for the trader to take control of their emotions and develop a strong mental attitude towards trading.
This can be reinforced by adoption of risk management techniques so that when losses occur, they only occur to a degree where they are recoverable and set out whilst in good mind-set.
This is what the psychology of trading is all about. There are numerous books available for traders to help them attain the positive mind-set and psychology when trading.
Learn About Account Size Management
Risk management simply means, account size management, or knowing how much you can trade and lose without suffering a crippling effect to your account, otherwise known as blowing out your account. For example:
Suppose a trader has $1,000 in his trading account, and decides to use a trade size which will take $200 of this money as margin for a trade. If the trade is lost, the $200 is lost and the account will be down 20%. Two more losses of similar magnitude will reduce the account by a further 40%. The trader will now have to make a gain of 150% just to get the account back to the starting level of $1000.
In contrast, a trader who uses a trade size which only commits $50 into a trade, and loses three trades of equal magnitude just like the first trader, would have lost only $150. The 2nd trader would only need 17.6% profit to bounce back to the starting level.
150% versus 17.6%: what is the difference between the two traders? The 1st one used a lot of risk in an attempt to gain big. The 2nd one recognized that staying alive in the market is just as important as making money. Account size management is the key to staying afloat during market adversity.
Using an demo account can help traders understand the importance of account size management by implementing various trade limits and experiencing the effects this can have.