Pros And Cons Of Demo Trading Accounts

Overview

There is no official or unanimously agreed time frame on how long a beginner should stay on a demo account. Some people can commit a lot of time to study demo trading, while others can contribute much less. These differences mean that people evolve at different stages in their journeys. 

Professional traders with several years of experience have highlighted that staying for too long on a demo account can be detrimental to a new trader for psychological reasons. Thus, we should attempt to employ a few solutions that should fast-track the transition from demo to live as seamlessly as possible.

The advantages of demo accounts

The clearest advantage of demo accounts cannot be understated, still proving that they are a necessary part for any beginner. Without demo accounts, people would lose a lot more money initially due to not understanding the right position sizing, for example. A demo account provides a simulated platform for the newbie to practice various skills to prepare them for the live markets. 

This simulated platform mirrors all the dynamics of the live markets. Demo accounts provide the foundation for developing some of the rudimentary yet sometimes overlooked aspects such as understanding:

• Spread.
• Bid and ask prices.
• Buy/sell stop and limit orders.
• Pending or market execution orders.
• Stop loss & and take profit, trailing stops.
• Counting pips

Those are just a few of the skills. A new trader also needs to be familiar with the numerous functions of their chosen charting software like drawing channels, Fibonacci, shapes, lines, inserting indicators, creating templates, creating profiles, viewing time-frames, etc.

The biggest advantage is the ability to back-test or test a myriad of trading strategies in a risk-free manner. Whether the trading strategies are new or tried-and-tested, a demo account is the only way to test how successful those can be in a real-life situation.

A trader can exploit the parameters of any strategy as many times as they wish without having to put any real money down. With all the benefits in mind, we can summarise that demo accounts help a rookie understand the fundamental education of the markets, navigating the software, and ultimately developing a trading strategy.

The disadvantages of demo accounts

The most evident con with demo accounts is it’s not real money. Furthermore, many brokers tend to fund these accounts with astronomically large amounts in the tens of thousands of dollars. In reality, very few traders fund accounts of this magnitude for the first time, which can be counter-intuitive. But the monetary aspect is not the biggest issue. The only two things that demo accounts cannot replicate are experience and emotions. Unfortunately, we can only learn these two traits on a real account and over a long time. The process of obtaining these is rarely perfect. 

A demo account cannot create a perfect trader that makes no mistakes. Regardless of the amount of preparation, errors are inevitable even in a live account. Of course, this statement isn’t to say a complete newbie should jump straight into a live account, though staying for too long won’t eradicate mistakes. Any failures experienced in a live scenario teach a trader far more than what could be gained from demo since you can’t simply ‘reset’ a bad decision in a live account. With a demo account, you can get away with risky trades without any real responsibility, although this would be almost impossible to sustain with real money.

Another contentious issue with demo accounts is that demo accounts are not 100% simulators of the live account. While no entity has technically proven this statement, through experience, there is a ‘feel’ between a demo and live account regarding slippage and execution. Demo accounts feel smoother, which doesn’t truly represent the more erratic nature of real markets.

Solutions to transition from a demo to live account

The typical scenario for most is staying on a demo account for a defined amount of time, usually several months, and going live thereafter. With the latter, the majority tend to fund what they believe is a sizable amount they can realistically afford to lose. The statistics back up the various claims of around 90% of traders losing money. So, how could this be reduced? There are two options:

• Opening a small or nano live account: By small, we could reasonably say a $100-funded account or less. A few brokers offer a nano account (also known as a cent account) where the trade size is 100 units of a currency or 0.001 minimum lot size. Yes, there is still risk, though it’s an affordable amount to lose. Trading an account of this size will give a new trader real experience and confidence to fund more at a later stage.

• Taking advantage of ‘no deposit’ bonus offers: A few brokers offer ‘no deposit’ bonus promotions, offering a small live account for clients to trade without the need for a deposit. This option is less risky than the first since there is no financial commitment from the trader. However, these accounts inevitably have more restrictions, and brokers usually cap the profit potential.

Conclusion

We should conclude that demo accounts should still exist in the industry for foundational purposes. However, traders should draw the line as to how long they stay in that phase. The differences between demo and live are so severe that it may explain the statistics of losing traders. Ultimately, the only way a new trader can progress confidently and thoroughly is by testing the waters sooner rather than later.