Demo accounts are a great way to get your feet wet in trading. If you’re a beginner, you should start trading on a demo account to get used to your trading platform, different market orders, and market dynamics.
However, semi-experienced traders will likely be better off trading with a micro account as demo trading fails to provide an accurate picture of real trading. Micro accounts can be opened with as low as $100.
In this article, we’ll cover what a demo account is, how much it can help you and when to switch to a real trading account.
What’s a Demo Account?
A demo account provides a realistic trading environment without risking real money. When you open a demo account with a Forex broker, you’ll receive virtual money which can be used to demo-trade, practice your trading skills, get familiar with the broker’s trading platform and get a first-time experience of the dynamic world of financial markets.
If you’re a total beginner in trading, it’s strongly recommended to start with a demo account first to get used to the different types of market orders, timeframes, the impact of news on exchange rates and all the functionalities of your trading platform. Almost all brokers offer demo accounts nowadays that help traders get their feet wet in Forex trading in a risk-free environment.
Demo accounts usually come with $10,000 or $100,000 of virtual money which can be used to explore the Forex market without any fear of losing real money. However, this is also one of the main disadvantages of demo accounts, as traders don’t have any emotional commitment to their demo-funds.
Differences in Execution
Although demo accounts resemble a real trading environment to a large extent, there’re still some subtle differences that you need to know about.
- No Re-Quotes and Slippage. Since demo accounts don’t have access to the real interbank market, you won’t experience any lags or re-quotes when placing a trade on a demo account. Re-quotes often happen on real trading accounts, but almost never on demo accounts. When markets are moving fast and your broker isn’t able to execute your order at the specified price, they’ll re-quote your order and ask you to confirm the new price. Similarly, slippages refer to a difference in the execution price and the price specified in your market order. When slippage occurs in the market, your order will usually be executed at a less favourable price. Since both re-quotes and slippage depend on the ability of your broker to execute your trade on the interbank market, they often happen on real trading accounts but not on demo accounts.
- Difference in Spreads. Demo accounts are designed to follow exchange rates available on real accounts, but sometimes they fail to do so. The price-feed of a demo account and a real account can be quite different, including bid and ask prices. While spreads in real trading accounts fluctuate depending on the interaction between buyers and sellers, they’re often fixed in demo accounts. When you open a trade in a real trading account when market volatility is high, such as immediately after an important news release, spreads may widen and increase your trading costs.
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Psychological Effects of Demo Trading
Besides differences in order execution and price-feeds, demo accounts also have a psychological effect on traders since they know that they’re not risking real money in the market. This makes it quite hard to observe emotions that are usually present when trading on real accounts.
Traders often feel fear and greed on real accounts, which are emotions that are not triggered on demo accounts. Overtrading is also something that demo traders often do. While there’s no risk involved when overtrading a demo account, it can become quite dangerous on a real account.
- No Emotional Commitment. Since demo traders trade with virtual money, there’s no real emotional commitment. Imagine a trade that is well in profit only to reverse soon after and hit your stop-loss level. A trader who trades on a real account will likely try to close the trade in profit or at breakeven. If the trade is losing, a real trader could act based on fear and hope that the market will again reverse in his favour. Emotional control plays an important role in successful trading. However, a demo account is not able to mirror those emotions which is why traders on demo accounts often make different trading decisions than traders on real accounts. There are many traders who manage to make a profit while demo trading, but start losing money once they switch to a live account.
- No Real Consequences – Demo accounts provide a risk-free trading environment. While this is great to get familiar with the basics of financial markets, it can become an obstacle for semi-experienced traders who want to sharpen their trading skills. It’s human nature to think about the potential consequences of specific actions. If there’re no real consequences, people become reckless and stop learning. This is what can happen when you’re trading too long on a demo account. The absence of consequences can affect your trading decisions in a negative way.
- Overtrading – Overtrading is a common mistake among traders on demo accounts. Overtrading refers to taking too much risk and trading very large position sizes that don’t fit in a trader’s risk management plan.
If there’re no consequences in demo trading, why should a trader follow strict risk management rules? While trading is all about managing risk, demo-accounts are completely risk-free and provide a distorted picture of real trading.
Benefits of Demo Trading
Despite the aforementioned disadvantages of demo accounts, they’re still the best way to get started with trading.
A beginner should always trade first on a demo account before switching to a real trading account. Even a professional trader may find demo accounts beneficial to manually back-test a new trading strategy.
- Getting Started with Trading. The most obvious advantage of demo accounts is to get started with trading. If you’ve never seen a price-chart before, don’t know what timeframes are or how to place a market order with stop-loss and take-profit levels, then you should open a demo account. They provide a risk-free environment to get a feeling of market dynamics. How do markets react when they reach important support and resistance levels? How to draw Fibonacci levels? How does an uptrend look like on a shorter-term chart? A demo account can help you grasp the basics of trading.
- Get to Know the Trading Platform. Another benefit of demo accounts is to get familiar with your trading platform. As a trader, you’ll regularly use your trading platform to place, modify and close trades and to analyse the market. Again, if you’ve never traded before, a demo account allows you to get used to all the features of your platform so you don’t have to look around once you start trading with real money.
- Understanding Order Types. There’re different types of orders in the Forex market. Market orders execute a trade at the current market rate while pending orders automatically open a trade once certain conditions are met. While you’re still on a demo account, make sure to experiment with different order types to learn how they work, such as buy stops, sell stops, buy limits, sell limits, OCO and trailing stops.
- Back-Testing a Trading System. Experienced traders may use demo accounts to back-test a new trading system before using it on their real account. Demo accounts offer a great way to do that without risking a penny. If your broker uses MetaTrader, you can choose to either manually back-test a trading strategy or use the platform’s built-in Strategy Tester.
Don’t Stay Too Long on a Demo Account!
A common mistake of beginners in the market is to stay too long on a demo account. When demo trading, a trader doesn’t have a real emotional connection with his funds. Bad trading decisions won’t trigger the same emotional response such as losing trade on a real account, and the absence of any real consequences makes it harder to understand the importance of sound risk management.
That’s the reason why you shouldn’t stick to demo trading for a long period of time. After you’ve got a feeling for the market and learned the ins and outs of your trading platform, it’s time to open a real account and start risking real money. Depending on your learning curve, this can take anything between a few weeks to a few months.
Most brokers offer so-called micro accounts which can be opened with as low as $100. Trading with $100 will help you more in becoming a successful trader than demo trading with $100,000.
Demo accounts offer a risk-free trading environment where traders can trade with virtual money. Beginners who are interested in the world of online Forex trading should always start with a demo account to get familiar with their trading platform and the basics of trading. However, demo accounts don’t come with the same execution lags you can find on a real account. Re-quotes and slippage are non-existent on demo accounts but often happen on real accounts.
What’s more, demo accounts don’t provide the same emotional commitment and don’t have any negative consequences when placing a bad trade. This makes demo accounts inferior to real accounts when it comes to practicing emotional control and creating sound risk management principles. If you’re already a demo trader, consider opening a real micro account with a small deposit. Always risk a small amount of your trading account on every single trade and observe your emotions when a trade becomes a winner or a loser.
Remember, when you’re just starting out with trading, it’s not about making money but about forming healthy trading habits with strong risk management rules. Also, only deposit money that you can afford to lose when opening a real account.
- Learn more, watch our tutor Phillip take trades in real time: Trading for Beginners Course