A question often asked is why results achieved on a demo account tend to differ from live trading? Among other things, the effects of trading psychology act as a key driver. Live market conditions draw in psychological elements typically not encountered in a simulated environment.
In a nutshell, live trading involves depositing actual funds into a trading account. Any profit or loss is real. A demo account is a live imitation – trading simulation. It mimics live prices closely.
Some traders feel the lack of emotional contact in a simulated environment negates the use of a demo account; others believe it’s a necessity. This remains a heavily debated topic.
Demo: to trade or not to trade?
Although a simulated account typically mitigates the psychological side of trading, it does provide a platform in which to develop a trading method, start creating a trading journal and become familiar with the platform’s functions.
An important aspect to consider with demo trading, however, is unless the trader attempts to treat it as a live account, a strategy’s results may be flawed. The reason behind this is simple: emotions affect decisions.
In addition to the above, re-quotes and slippage are an aspect worth considering. Since demo accounts don’t have access to the interbank market, traders won’t experience any slippage or re-quotes. Slippage is best described as the difference between the price requested and the price at which the order is filled. A re-quote is similar though rather than the broker going ahead and filling your order at a negative/positive price, a notification with the option of executing at the available price is sent, be it a favourable or unfavourable price.
Live trading will also teach you things about yourself you never knew existed. You may believe you’re a patient person (and you may well have been on demo), but before real money is on the line it is difficult to know. Fear and greed, two opposing emotional conditions, are also principal drivers that have a profound impact on our lives and trading. It is well documented greed inflates market prices during a boom and fear depresses action through busts.
A demo account certainly has its uses, and should form the basis of all traders’ education. A common mistake a beginner makes is staying too long on a demo account. Bad trading decisions won’t trigger the same emotional response, and the absence of any real consequences makes it harder to understand the importance of sound risk management. It is often recommended once you record consistent profits on demo, you can begin thinking about taking the leap to a live account.
Transitioning from demo to live
The real test comes when a trader enters the market using live funds. A different sensation is felt, generally emphasising risk has entered the equation.
While emulating demo results is unlikely on a live account, the following points will help make the transition easier:
- Familiarise yourself with the new risk profile and establish competence at this level before considering adding additional funds.
- Do not panic if your first, second or even third trade is a loss. Losses happen – it’s simply the cost of doing business. Trading a method that boasts a positive expectancy will help alleviate this. Expectancy = (average gain * probability of gain) – (average loss * probability of loss). For example ($200 * 30%) – ($50 * 70%) = $25 – this means the trader can expect to win $25 per trade on average.
- Keep a trading journal. While an impactful tool used to analyse mistakes and trading performance, many are guilty of not keeping a trading journal. Doing so, however, tracks experiences in the market, helping to address any psychological/market-based issues you may need to improve on.
- Trade the plan. Without a plan you’re effectively trading from a reactionary state. In other words, an emotional state. Without a trading plan, the act of trading becomes frustrating, stressful and a pointless exercise. Following a plan will help employ discipline and structure. Trading strategies, forms part of the overall trading plan, vary according to the individual trader. Despite the differences, each trading plan should display clearly defined rules of engagement for both entry and exit signals.
- Don’t focus on the money. Your top priorities should be developing discipline, trust in your rules and your system and building a strong trading routine. Those things, along with a strong and conservative money management approach, will make sure you lay a solid foundation at the beginning which you then can leverage later on.
- Resist the urge to rush in and prove yourself. Take your time and trade according to your plan.
Switching from demo to live is often an exciting prospect for most. The typical trader often sees no reason why their demo results cannot be replicated on a live account. The trouble comes with having your hard-earned money on the line, causing stronger emotions to appear, which were masked when trading simulated funds. Sweaty palms, a dry mouth and a pounding heart beat are common symptoms when one first experiences live trading.
Moving forward
Once satisfied with demo results, begin trading with a small live account of no more than $1,000, or if feasible, the same account value you traded on demo.
Grow your skills and your account concurrently. Familiarity with your risk profile at each step is crucial in order to trade from an objective state of mind.
