Becoming a successful trader involves practice, lots of practice. Demo accounts allow us to practice without risking real capital. Learn the pros and cons of demo accounts, and how to get the most out of the experience so it actually benefits you when you switch to trading real money.
If your trading journey is just starting, or even if you are an experienced trader trying out a new strategy, a demo account is your best friend. 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, and assess the strategy’s profitability.
Demo trading uses real market prices, but instead of placing real trades, your trades are simulated so no actual money changes hands. Demo accounts are free to use, offered by many brokers, and are a good way to see how various markets and assets move, practice capitalizing on those moves, and develop strategies.
The Goal of Demo Trading
The goal of demo trading isn’t to make as much money as possible. Interestingly, that shouldn’t even be our 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 not 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.
Following a plan isn’t easy. Our minds will want to place trades which aren’t part of our plan, or skip trades that are. Our mind may want to hold onto losing trades, letting them mount, or cut profits and losses too quickly. All these errors are caused by emotion. We can’t get rid of emotion, but we can learn how to control our emotions so we do the right thing.
The added benefit of demo trading is that we get to work on our discipline in a no-risk environment. As long as we continually only take the trades we are supposed to, we are building our discipline muscles. Discipline only increases by being disciplined. There are no short-cuts.
Some traders view the demo account as a playground because there is no risk. They take big risks, make trades that aren’t part of a strategy, and follow their impulses instead of a method. When this occurs the demo account loses its effectiveness. The demo account is only effective if you treat it with respect and only take the trades that align with your trading plan. Do this, and you set yourself up well for the eventual switch to live trading once you are consistently profitable in the demo account.
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 feel confident that what worked in the demo account will work in the real world, try to make the demo account experience as real 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. Only practice building good habits.
- Your demo account should reflect the monetary value of what your real account will be. 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 the recommended capital for 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.
Practice Trading Anytime
The best way to practice day trading or swing trading that I have come across is the Market Replay Simulator. A market replay simulator allows the trader to download historical trading days and then trade them as if they were live. Place orders and see how they would have turned out as the price unfolds tick by tick, revealing exactly what you would have seen had you been trading that day live.
I typically only day trade for two hours a day. When I started trading futures, I would demo trade one day for two hours and then have to wait till the next day to practice trading that same two-hour period. By downloading historical days and then trading them, I was able to get two or three days worth of practice into one, and could even practice on the weekend. The more days I traded, and the more conditions I saw, the more confident I felt switching over to live capital once I started seeing consistent profits in the demo account.
I began trading in 2005, and even with more than 13 years of experience, I still find replay simulators to be a valuable tool and use them regularly to work on issues I notice in my trading. If you aren’t using one, you may be unnecessarily putting yourself at a disadvantage.
Forex replay simulator: The SoftFx Forex Simulator is for traders who want to practice forex trading using the MetaTrader4 platform with an advanced simulator providing access to 10 years of historical days to trade in 33 currency pairs and several commodities and stock indexes. The software has a one-time fee of $99 (only works on PC, not Macs). The nice thing about this simulator is that if you are a forex trader most brokers offer MT4, so you can gain experience on the platform while you practice. MT4 is a free trading platform.
Futures replay simulator: NinjaTrader, a popular futures trading platform, offers a Market Replay connection. You can download a free demo account that lasts for about 30 days, and use the market replay connection for free during that time. While using the replay connection is free, if you decide to trade live with NinjaTrader, the platform costs $999, or is free if you trade through one of their affiliated brokers (trade commissions are increased if the platform is not purchased).
Stock replay simulator: TradingSim works best for replaying and practicing on stocks. The simulator costs $297/year, per market (futures are also available, but NinjaTrader is a viable free option).
Differences Between Demo and Live Trading
Your demo trading may go fantastic, pulling in loads of money, yet often demo account conditions are more favorable than live market conditions. If you account for the following factors, which reduce profitability, is your demo method still likely going to viable in the real world? 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 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. 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 once you start live trading.
- 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 (slippage), 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. In the live market your orders affect how other traders act. You may only get 100, 300 or 900 shares because other traders want in too, leaving you with a smaller position on “good” trades that are quickly moving in your favor. Unfortunately, you’ll get the full 2000, or whatever amount you wanted, 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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Final Word on Demo Trading
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.
Consider using a market replay simulator to get in more practice during times when you usually wouldn’t be trading.
By Cory Mitchell, CMT