Becoming a successful trader involves practice, lots of practice. While eventually you’ll practice your strategies and methods using a real money account, when you’re starting out it’s recommended you use a demo account. If you’re brand new, the demo account allows you try out strategies, see what works and spot your personal strengths and weaknesses. If you already have some strategies you’ve created or learned, the demo account gives you the opportunity to practice that strategy, fine-tune it, make it second-nature to you and assess the strategy’s profitability.
The Goal of Demo Trading
Your goal in demo trading shouldn’t be to make as much money as possible. In fact, that shouldn’t even be your goal with live trading. The goal of making money isn’t specific enough. Making money requires a methodical trading approach and a well laid out trading plan. Your only goal in demo trading is to create such a plan, and then follow it. Following a plan is success, because a plan produces repeatable results. Follow a plan and if over several months you’ve made a profit, likely you can continue to produce profits. Random demo trades, which by chance produce a profit, are much less repeatable.
When you open a demo account make it your goal to create a plan and follow it. That way you know if the plan works. If it doesn’t you can rule that strategy out, and focus on something else. Once you find something that works, and you’ve created a plan for it, you’ll continually reap benefits of that plan going forward.
The Demo Account Should Mirror Your Circumstances
Eventually you’ll want to take your winning strategy from the demo account to a live account, and make real money. To know a strategy will work in live trading, setup the demo account like a live trading account…or at least as much as possible.
- When trading a demo account think of it as real. It’s fake money, but if you wouldn’t try a certain tactic with real money, don’t try it with play money. Stay disciplined. Play money or not, this is your practice ground. Don’t practice bad habits.
- Your demo account should reflect what your live account will be like when you start trading with real capital. If you have $10,000 saved for day trading, your demo account should also start out with $10,000. Don’t trade a $1,000,000 demo account if you only have $5,000 for live trading. Trading the former will not properly prepare you for trading the latter. See How Much Money Do I Need to Become a Day Trader for more on recommended capital day trading.
- Your demo software/platform should be the same software/platform you intend to use in live trading. Part of demo trading is becoming comfortable with your trading platform and broker. Never start live trading with an untested/unknown platform.
The best way to practice day trading I have come across is the Market Replay connection. It’s a free tool and an excellent way to efficiently practice at any time of day…if you want to trade using the NinjaTrader platform.
Account for Demo and Live Trading Differences
Your demo trading may be going fantastic, yet often demo account conditions are more favorable than live market conditions. If you account for the following factors, which will likely reduce profitability, is your demo method still likely to produce a profit in live trading? If the method isn’t going to be profitable in live conditions, focus your time on something that will be.
- Fear: In live trading there’s fear, in demo trading there isn’t. Make the demo experience as real as possible. Pretend as much as possible the money is real. Fear distorts our perceptions, and can cause us to question our trading plan, skip trade signals, take trades we shouldn’t, get out of trades too early, or let losses mount (see the Trading Psychology section). Condition yourself for this in the demo account, and it’ll play less of a role in your live trading. Risking 1% (or less) of account capital on each trade will also help keep anxiety at bay.
- Slippage: In demo trading you usually get the price you want. Your entries and stop loss orders fill at the price you specify. In the real market that doesn’t always happen. Market orders may fill at a different price than expected, and stop loss orders are especially susceptible to slippage when the price is moving quickly against you. Assume that some losses will be bigger than anticipated. Is the demo strategy still profitable?
- Position size: Usually in a demo account you’ll receive the position size you request, no matter what it is. If you want 2000 shares of a fast moving stock, you get 2000 shares. That may not always be possible in the live market. The in the live market your orders affects how other traders act. You may only get 100, 300 or 900 shares when many other traders want in, leaving you with a smaller position on “good” trades, yet you’ll get the full 2000 if the price is moving against you. “Partial fills” greatly affect profitability. View the Level II screen of the stocks/futures/currencies you trade to make sure the market can actually give you the position sizes (with ease) that you’re practicing with.
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Treat a demo account like a real account. What you do here determines your future success. Get into good habits, like following a plan, setting up the account to mirror your circumstances and training yourself on the software. Imagine how fear will affect you when real money is on the line, and push through it, sticking to your plan. Account for slippage and partials fills. Is your method still profitable when accounting for these realities? The more precise you make your demo trading, the easier it’ll be to transition those precise methods into the live market, and start making real money.