Think Like A Trader Blog

Thursday, 23 November 2017

Demo Trading Benefits and Drawbacks. Is it Useful?

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The short answer to this blog would be – ‘Yes’. However, there are also a lot of pitfalls in regard to demo trading that people don’t consider, and they can end up doing a lot of long term damage.

First thing first – I didn’t use a demo account when I got started. I consider that to be a huge mistake, and one that I paid for with lots of losses. I wandered around the markets in the dark, bumping into random things, throwing more money at it and hoping something would work. It was stressful and in all honesty, it was stupid. I made the fatal mistake of looking at demo trading as a wasted opportunity. My idiotic mind-set was that I could be making real money rather than pissing around on a demo. Of course, the markets had a very different idea. I ended up losing lots or real money, rather than demo money.

In this blog, I am going to outline both the benefits and the limitations of demo trading.


The Benefits of Demo Trading

1) If we start at the very core of what a demo account should be used for – learning – then we are off to a good start. No matter how many videos you watch, courses you take, or books that you read, when you first try and start trading, you don’t have a clue what you are doing. You may know all the technical terms and when to go ‘long’ or when to ‘cover’ positions, but you have never actually done it before.

The trading platform you use will take some getting used to. You will need to learn how to place orders, how to set stops, how to calculate position sizes etc. This all takes time. A demo account is the perfect place to do that. You can press any of the buttons you want, you can move things around and experiment with different order types, all the while safe in the knowledge that you aren’t risking any real money. Do you really want to calculate your stop incorrectly on your first live trade and end up losing double what you meant to risk? Play it safe and spend a couple of weeks learning how everything works.

2) The next huge benefit of demo trading is in terms of perfecting a trading system and how you execute it. The market has more variables and will produce more situations than you can consider. The only way to pinpoint these is by executing a trading plan in real time. Back testing is great, but it will never give you the ‘full-picture’. I can honestly say that no trading system I have developed whilst back-testing ever remained the same after I started trading it. You watch the markets and you learn. You adjust.

It doesn’t matter if you developed a trading plan or if you bought one. Once you start trading, there will be issues you need to figure out.

‘X happened today when I was in a trade and I didn’t know what to do. So, I now need to go back and look at the course and figure it out/look at how I can adapt my trading plan.’

‘I was looking for X today and Y was my sign to skip the trade. However, a Z appeared instead and I didn’t know what to do. I took the trade anyway and suffered a loss. I need to figure out if what I did was correct or if I need to adjust my approach in those situations.’

Note what we are doing here. It is nothing fancy, it isn’t using the demo account to find the holy grail in trading, it is simply allowing ourselves to learn in a safe environment. When learning to box, you don’t get thrown in a ring with a professional boxer and told to hold your ground on your first lesson. Instead, you start working on the basics by yourself, shadow boxing and on pads. Mistakes are identified, weaknesses corrected. You build up slowly until you know exactly what you are supposed to be doing at any given moment.
The more of the technical side of things you can master on a demo account, the easier it is going to be when you switch to live trading. Like building the muscle memory of throwing a jab as a boxer over and over again whilst in training, you want to build a solid understanding of your trading plan, so it is almost automatic when it comes time to make decisions.

The Limitations of Demo Trading

Now you have read everything above, let me hit you with a hard truth. When you first step into live trading, the market is still going to kick your ass. There is no escaping that fact. Let’s look at the main drawbacks:

1) Although you have prepared yourself as much as possible by using the demo account, it in no way prepares you for the emotional side of trading. So many people read that trading psychology is the most important aspect of trading, over and over again and then go right ahead and discard it. Don't let that be you!

I don’t care how well you now know your system, or how much you have convinced yourself that ‘I am imagining my demo money is real money.’ None of that is going to matter. You are going to panic, you are going to make mistakes, you are going to revenge trade.

This is the area where most people really struggle. Almost no one believes it is going to be an issue for them, and when it does appear, they put their head down and run straight into a wall.

That is why it is so vitally important to first master your trading on a demo account. That leaves you with the job of mastering the psychological side of things when live trading, and the 'ABC' technical process is already ingrained in your mind. You are lifting some of the weight off of your shoulders.

Can you imagine not knowing exactly what you’re supposed to be doing in terms of your trading plan AND suffering through emotional trading? Well, you don’t need to imagine. It's exactly what I did, and believe me it isn’t a fun experience.

A demo account can’t prepare you for the psychology of trading, but it can help you build as much as possible before then. Think back to the boxer – they know what to do at every stage. They know their plan, they have sparred with people and understand how to react. But the first time they get into the ring for real, emotions are going to be tearing through them. And the first time they get punched in the face, it suddenly becomes incredibly difficult to remember the plan, let alone follow it. However, the better they know the plan, and the more they have practiced, the easier it is going to be.

2) Cockiness. I would say this is the biggest issue that comes from demo trading and it is a dangerous one. I see it over and over again. I warn people about it as soon as I detect it through speaking to them, and in probably 90% of cases I am ignored.

The very real truth is – Profits in a demo account do not translate to profits when live trading!

This relates fully to the first point. You have not built up an ability to manage the emotional side of trading. You are not risking real money. It is a completely different experience.

The problem is that on a Demo account, let’s say you have £10,000 or £100,000. You follow good risk management and you watch large amounts of virtual money roll in. It seems easy and you get flooded with dopamine so that everything in the world seems rosy and you’re safe in the knowledge that you’re going to be a millionaire in short order.

When you move to a live account, you should now be looking to risk minimum position sizes. It should be about experiencing and then tackling the emotional side of trading. You should be taking baby steps and building very slowly. But you have that demo experience. You KNOW how to do this and suddenly when you see a £10 profit for a perfect trade, your mind chirps up with things like ‘Only £10. What is the point in risking so small? You KNOW what you’re doing.’

Invariably people up their risk. I have even seen people plop thousands on a credit card in order to swell their trading power.

It ends in disaster. Always.

Think of moving to a live account the same was as learning to ride a bike and taking the stabilisers off. Yes, you now know what you’re doing, but cockiness will still invariably lead to a spill.

So, to answer the question – Is Demo trading useful?

I absolutely recommend that beginners use a demo account. It is invaluable. However, it must be approached with caution (just like everything else in trading). Don’t allow it to inflate your ego and cause long-term damage. Take baby steps and build solid foundations for your future.

I hope you’ve all had a great trading week!

James Orr

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