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posted on 25 March 2017

Avoiding The Trap Of The Demo Trading Account

by Sam Evans, Online Trading Academy

Online Trading Academy Article of the Week

One of the biggest advantages of the Global Currency market is that it is very easy for traders of all levels to open a simulated trading account with great ease. Brokers in asset classes like Equites, Options and Futures make it much harder to open demo trading accounts without funding a live account first and some don't even offer a simulator at all.

We have no such worry in Forex, meaning it's so much easier for us to dip our toe in the water before jumping in fully. However, too much time on the trading simulator can also have a hugely negative impact on a trader in the longer term. In this article, I want to share some thoughts on this subject so you don't fall into the same traps as many others have before you.

Success on a simulated trading account may not equal success in live trading and here's why.

Why Start Trading on a Demo Trading Account?

If you are new to trading of any kind, it is vital to take advantage of the wide variety of tools available to you from the very start. If you have never used a trading platform before, then it can be quite daunting the first time you work with one. I remember feeling like I was staring at the flight controls in an airplane cockpit when I turned on a charting and execution program for the first time! It is vital that you know how to place an order in the market with ease, and then ensure that you know how to place a stop loss order to protect your capital, set exits to take profit at predefined levels and manage the position throughout the trade itself. It could cost you a lot of money if you place the wrong order and trading is hard enough without this happening. I could tell you plenty of horror stories involving traders I have met forgetting to cancel a stop loss order after closing a winning trade, only to wake up the next day to find themselves in an open position and suffering heavy losses. To fully ensure that you can be confident with your execution system, it is necessary to practice order entry, and the demo trading account is perfect for this task.

Another reason to start with a simulated account is that it is the ideal vehicle to test your strategy in a safe environment for the first time. When I teach a class, I introduce the students to a wide variety of technical tools and methods to trade with consistency and I have found that over time, we all gravitate to a preferred style which matches our personality. Discovering your ideal method of objective analysis and execution is a key requirement for any novice trader, and it is always a good idea to try out a variety of strategies to find out which is the right one for you. Again, the demo account is the perfect place to start the process, with no actual financial risk on the table. It is only after thorough testing and implementation of a setup that we can hope to gain confidence in our methodology, so it makes perfect sense to try this out in a safe arena. However, while the simulated trading account offers us a selection of advantages to aid our trading growth, it also suffers from the duality of providing a myriad of potential hurdles as well.

Drawbacks of Simulated Trading

I have lost count of the number of traders I have met who have suffered from the confidence which they get from the demo account. Typically, they have tested their strategy with great success on the demo trading account over a sustained period of time with very strong results, only to find that when they moved over to a live account they failed to emulate the same outcome of results. This is a common issue for the novice because they haven't yet tested their nerves. You see, no matter how disciplined they are with their trading on the simulated account, they ignore the fact that the trades are still not real, and that when real money is on the line emotions can easily get in the way. Usually the novice is not as confident about placing a trade as they were on the demo and ends up missing great opportunities due to a lack of confidence in pulling the trigger, only to watch the market go off without them onboard. When they do finally place the orders, things then fall apart after a few losers and suddenly the tempo changes to the scenario of jumping in and out of the market recklessly in a desperate bid to claw back the draw-downs, resulting in far greater losses than were experienced in the safety of the demo account.

Experienced Traders and the Demo Account

Even as an experienced trader who is back-testing a new strategy on the simulator with great success, you still need to be aware of the emotional impact and special circumstances that may apply when you are putting the rules to the test in a Live environment. There is the FX Dealer Spread which needs to be taken into account, especially if your strategy is automated and executes during the quiet hours of the Asian session as spreads can become very wide when liquidity dries up, making profits much harder to attain. This is something which is not often factored into a back-test and you should not forget to account for a varying spread if you are such a trader.

Another issue commonly found with more experienced traders is that of the fear factor which pushes them back to the comfort zone of the simulated account. Things can be going well for a while on the live account, with a period of consistent and profitable trading becoming the norm. Only one day it all changes in the blink of an eye, with a confidence-shattering losing streak quickly hitting the emotions where they hurt most. The run of sustained losses forces the speculator to switch off the live account and move back to the safety of the demo world. Now understand this, I am by no means saying that is a bad thing to do and we should all enforce the discipline to halt our activities and assess our technique during losing streaks. However, this can also become a double-edged sword if we are not careful. Why? Because we run the risk of stepping away from the plan and trying out a few new ideas on the demo which we would not normally do, which in turn can be damaging to the original plan itself. We must understand that no system will give winners all the time and the worst thing a trader can do is change the rules in mid flow.

The demo trading account can also lure the experienced trader into a false sense of security. When they go back to the demo, the emotions are easily removed and just like the novice in the early stages, they will be using a transparent confidence when pulling the trigger. After a few winners on the simulated platform, they go back to the live arena and then suffer from an inability to allow the winning trades to fully run, taking small profits to get a feeling of relief from losing. Yet we must remember that small losses are part of the game and if we don't counter these with larger average winners, then our trading runs the risk of hitting a wall once more. Remember that when all is said and done, those simulated profits only pay for those simulated bills!

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