Demo Trading vs Real Trading

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Demo accounts are where most people learn how to survive the ups and downs of trading financial markets. However it’s useful to keep in mind the differences between demo trading and live trading. Demo accounts are usually offered by brokers with the best possible terms and fees – conditions which may not transfer to live accounts.

Demo trades often don’t suffer the handicaps that we have to cope with when using real accounts. So how do we deal with these challenges of moving into the “real world”?

Moving to a Real Account: What to Consider

You’ve tested your trading strategy for a few months with practice money and it is now showing steady and promising returns. At this point, you may have decided it’s time to move to a real account.

This transfer process might seem straightforward and simply an administrative step. But actually, it can create significant challenges.

Moving from a demo to a real account: Challenges
Challenges of moving from practice to real trading © forexop

Traders are often surprised to find that their strategy that was highly profitable on a demo account doesn’t produce the same returns after making the transition to a real account. So what can be done to improve the chances of making a successful transition.

What are demo accounts?

Firstly, let’s examine what demo accounts are and why they exist. Demo accounts are the trading world’s version of a “sand box”. They allow traders to use virtual money in a simulated trading environment.

They allow you to practice the mechanics of trading without the risk of losing real money. They also allow convenient testing of new and unproven trading strategies.

Just about every broker offers a free demo account where you can practice for a certain length of time. The spreads, fees, swap interest, instruments and trade execution should all replicated those of real accounts.

The profit or loss you see in a demo account should be able to be replicated in an account using real money. But there are several reasons why performance isn’t always the same after moving to a real account.

These reasons can be grouped into two categories: technical and behavioral. The rest of this article examines these in more detail.

Technical Differences of Demo Trading

A demo account tries to model a real world trading environment. What this means is that the execution of trade orders is simulated to show what should happen in a perfect case. This being when the order you enter executes at exactly the price, time and in the quantity you would like it to.

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The problem is that real trading involves many dynamic variables that are impossible for a simulation to properly model. These include supply and demand constraints, order processing and information transfer limitations as well as imperfections in the various technologies – some of these are beyond the broker’s control and are to do with the market.

Some demo systems recreate these imperfections better than others and make a more realistic trading environment. This can be done for example, by mirroring the live system. This solution however can create a “drain” on the broker’s live trading platform.

Less sophisticated demo platforms may give you an unrealistic experience. For this reason, it is always worth asking your broker for a technical description of how their demo system works and how closely it mimics real trading. You can sometimes find details in their terms and conditions.

Here are some of technical problems in more depth.

Latency Issues

The first problem in a real trading environment is that of latency or slippage. No electronic trading system is perfect. There will always be time lags between receiving an order and the platform being able to fill it (executing it or queuing it in the market on the instruction of the trader). These time differences may be small, but they can create discrepancies in trading performance – especially when markets are moving quickly.

Supply/Demand Constraints

Demo accounts don’t complete real transactions. And because they don’t interact with the market it is difficult for them to model supply and demand properly – because every interaction in a real market changes the dynamic in some way (however small).

The quantity of lots bid or offered will never be unlimited, despite the size of forex markets. While the volumes traded are large, so is the number of other participants.

It means that if other orders are ahead in the queue, an order may not achieve the desired entry price. This happens because the bids or offers displayed at the time have already been matched with other buyers or sellers. With a market order a trade is filled at a new price.

With some trading models this triggers a requote and the trader has to re-enter the order. Otherwise, the entry price can be significantly different than that which was entered.

Similarly, if you placed a stop/limit order to execute at a certain price level, the entire order may not be filled at one instant due to insufficient supply or demand at the point the execution price is reached.

Liquidity Gaps

A demo platform may publish a quote at which to trade when in truth there is no market. It’s not usually an issue when trading major currency pairs owing to the size of the market and because retail order sizes are usually relatively small.

There are times when an order cannot be filled because there is “no market”. These are known as liquidity gaps and they happen where there aren’t enough market-makers quoting at a given instant. This can happen for example when the market is adjusting to an important breaking event. This forces the price to “gap” a certain distance.

In real trading such an order would not be filled at the quote price because the broker’s matching system would find that there was no price to take at which to complete the order. In some simulated trading systems the order may be filled anyway, even when the price was in a liquidity hole.

Psychological Challenges

Trading with simulated money removes the monetary reward/penalty aspect. But research from behavioral finance shows that this eliminates one of the most critical elements and challenges of trading in financial markets.

It is common to underestimate the psychological difference between trading with play money and trading real money. While the mechanics of trading aren’t any different, trading with real money can cause behavioral changes that lead to different decisions.

With a practice account there are no consequences to trading decisions. With real money the emotions of fear, greed, loss aversion, and regrets of missed opportunity come to the surface.

Of course, if your strategy is a piece of software then this should be less of a problem. But only if an identical setup is used. Expert advisors can fall over when deployed to real accounts, often because of the much lower amount of real capital that is available. The advisor may have been tested with an unrealistic safety margin and this cannot be matched on the real money account.

With the move to real trading there can also be a lowering of risk thresholds and a more conservative approach to trading.

To summarize this means the trader can achieve lower returns because of

  • Having less capital to play with
  • Using higher/lower leverage
  • Tighter stop and take profit levels
  • Lower trading frequency
  • Less aggressive trading practices
  • Panic trading decisions – e.g. closing positions on drawdown

Tips for Successful Demo Trading

Choose a “like for like” account

Firstly when choosing a demo account it is best to opt for one that is closest to the account you plan to trade with. It doesn’t make sense to use a USD 100,000 demo account that trades standard lots when the one you plan to use will be a EUR 250 micro account.

Using a realistic account size and currency will help you to familiarize with the lot sizes, the fees, and the profit and losses on each trade. If you trade with a high cash balance on a practice account, this will give an unrealistic sense of the margin for error.

Use a real money account

One thing that some traders do is bypass demo trading altogether and start with a real account with a very low balance.

Consider trading competitions

Some brokers have monthly contests for traders using demo accounts and give large cash prizes to those with the best performance. This makes demo trading a more realistic experience because there is a financial reward at the end of it. It can also make the process more enjoyable and engaging.

Some websites offering forex competitions include:

  • Dukascopy
  • Hotforex
  • FXCM
  • MyFXBook

This option is good for risk-averse traders who don’t want to place their own money at risk. There is no downside, other than time spent.

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