A practice trading account, also frequently referred to as a ‘demo’ account, represents a simulated trading environment, which allows the trader to advance his skills without running the risk of losing any money.
Trading on a practice trading account has many perks, chief among which is the ability to polish the parameters of one’s strategy. Yet there are also certain hidden dangers, which warrant closer examination, too.
This article is an educational guest post. It was written by Plamen Stoyanov from Trendsharks.
The crucial problem of misusing practice accounts stems from the trader’s inability to draw informed conclusions about the fundamental nature of trading early on in his career. Novice traders are especially impressionable at the beginning, which means that they are more likely to develop bad habits due to their naivety without even realizing it.
Starting at the beginning, the first thing that beginners need to know about practice accounts is that they are primarily intended to serve as a broker’s business card. They allow prospective clients the opportunity to familiarise themselves with the trading platform and get a general idea of what services are offered by the particular broker. Potential clients of the broker can then use this simulated version of the real market environment to test out all of the important features of the broker’s platform, such as the bid-ask spreads, order execution speeds, the user-friendliness of the platform, and more.
Brokers recognize that many inexperienced traders are going to decide whether or not to open and fund a real trading account on their platforms based on their impressions of the practice account. For this reason, some brokers might be inclined to meddle with the parameters of this simulated environment to make it more appealing. In other words, tip the odds of demo-profiting in favor of the client, wink, wink!
Brokers can effectively modify the behavior of the price action on their demo platforms in such a manner that is most beneficial to the trader so that he can get the impression that trading is quite simple and easy. Less reputable brokers can even manipulate the direction of the price action in this simulated market environment in order to turn the prospect client’s positions profitable. After all, who wouldn’t be tempted to get started with real money if his impression of the trading business is that it entails limitless opportunities?
While on the subject of making “easy profits” on a practice account, new and inexperienced traders can also, oddly enough, suffer from the weight of their own success. Beginners can quite easily stack up several profitable trades in a row, which might be compelling enough to convince them of the superiority of their skills without any way of confirming this. Accordingly, the weight of losing trades cannot be properly digested as well because, yet again, the demo platform cannot simulate the damaging emotional impact of real-world trading conditions.
Novice traders have no way of knowing whether their strategy is going to be consistently successful in the long term when they are compelled to focus solely on the technical aspect of trading on a demo platform. The carefree attitude of buying and selling on a simulated platform does not provide any inkling of just how much practice is enough for the novice trader to make the jump to trading with real capital.
The bottom line is that without the threat of having to deal with the consequences of lost capital, traders are less incentivized to apply caution when there is no underlying risk. Unless one is able to exert very tight self-control, trading on a practice account can twist the trader’s perceptions to a point where he has gained a completely false impression of what risk management really is.
While it is an inherently good thing that traders are free to test out as many new approaches as they please, the safety of the demo platform can make one careless with all that freedom of trial without the repercussions of error. That is not to say that all first-timers need to make the immediate jump to trading with real money in order to grasp the weight of emotional decision-making right from the get-go, not at all.
However, they need to keep in mind that not even the most intricately programmed platform can teach you how to manage your fears or mitigate your greed. Learning about the psychology of markets takes time and effort, demanding small and incremental changes to your trading approach that are determined based on past experiences with real-world implications.
Ultimately, practice accounts are best used as a supporting tool in the arsenal of a trader who already knows what he wants to achieve and how to get there. Yet, when he nests his overall outlook on trading solely on his experience on a practice account, that trader bounds himself to a perception that is wholly rooted in the technical aspect of trading.
Arguably, the most detrimental habit that one can develop on a practice account is to get used to trading with hundreds of thousands of “practice” dollars. Opening a demo account with $50 000 or $100 000 dollars can be achieved with a few simple clicks. Before you know it, you are placing orders with sizes that would otherwise make even seasoned Wall Street elites sweat with anxiety.
When dealing with positions with astronomical margins, making several thousand dollars on a price movement of just several pips becomes something of a banality after some time. On the other hand, blowing out your account is no problem as well, since brokers make sure that it is just as easy to restart your one-percenter practice account; again, in just a few simple clicks.
It is quite easy for a newbie to become entranced with the seemingly limitless possibilities that stem from such limitless opportunities. However, how often is it that a first-timer would begin his experience on the capital markets with an initial deposit of $50000?
In reality, most people prefer to invest something in the range of several thousand dollars initially to get a sense of how things actually work out when there are real stakes. This massive discrepancy alone is enough to illuminate just how divorced such practice accounts are from reality.
Ultimately, one should remember that mastering trading on a demo account is not a goal in itself. At best, they can be used as a supporting tool to help perfect certain aspects of one’s trading strategy. At worst, overreliance on practice accounts can lead to dependency on them and misconstrued perception of reality.
Use practice accounts to polish your entries into a trade, to test out various trading indicators, to build a comprehensive strategy that fits your style, but remember that the general trading experience is not exhausted with how good of an entry or exit you are able to get out of your positions.
Ultimately, mastering trading on a demo account is not the goal. They can help to practice your trading strategy. But remember, practice accounts can lead to a misconstrued perception of reality.
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