Firstly I would like to wish you all a very Happy New Year and all the best for 2013! I am most pleased to be heading into another year of trading and teaching with Online Trading Academy and I am looking forward immensely to working with our fantastic community to transform even more lives in the coming year than ever before.
With this in mind, I am aware that the people who read these articles, come with a truly varied degree of trading experience, from the seasoned speculator to the fresh novice. However, no matter what level or experience you hold in the FX markets, you should always be humble enough to recognize that you should constantly be open to the idea that you will always be a student of the market in some way or form. I mention this because I would like to take the time to talk about the role of Demo accounts in trading, as they are used by not only traders who are brand new to the markets but also by those more experienced in trading and wishing to run tests on a new strategy or technique for the first time. Either way, it is very important to know how to use the simulator in the most realistic manner if you are hoping to get the most from the experience in the end.
First of all let’s explore why we should all start our trading on a demo account. The reasons are simple: If you are new to trading of any kind, it is vital to take advantage of the wide variety of tools available to you from the very start. If you have never used a trading platform before, then it can be quite daunting the first time you use one. I remember feeling like I was staring at the flight controls in an airplane cockpit when I turned on a charting and execution program for the first time! It is vital that you know how to place an order in the market with ease, and then ensure that you know how to place a stop loss order to protect your capital, set exits to take profit at predefined levels and manage the position throughout the trade itself. It could cost you a lot of money if you place the wrong order and trading is hard enough without this happening, as well. I could tell you plenty of horror stories involving traders I have met forgetting to cancel a stop loss order after closing a winning trade, only to wake up the next day to find themselves in an open position and suffering heavy losses. To fully ensure that you can be confident with your execution system, it is necessary to practice order entry and the demo account is perfect for this task.
Secondly, a simulated account can be the ideal vehicle to test a trader’s strategy in a safe environment for the first time. When I teach a class, I introduce the students to a wide variety of technical tools and methods to trade with consistency and I have found that over time, we all gravitate to a preferred style which matches our personality. Discovering your ideal method of objective analysis and execution is a key requirement for any novice trader, and it is always a good idea to try out a variety of strategies to find out which is the right one for you. Again, the demo account is the perfect place to start the process, with no actual financial risk on the table. It is only after thorough testing and implementation of a setup that we can hope to gain confidence in our methodology, so it makes perfect sense to try this out in a safe arena. However, while the simulated account offers us a selection of advantages to aid our trading growth, it also suffers from the duality of providing a myriad of potential hurdles, as well.
I have also lost count of the number of traders I have met who have suffered from the confidence which they get from the demo account. Typically they have tested their strategy with great success on the demo account over a sustained period of time with very strong results, only to find that when they moved over to a live account, they failed to emulate the same outcome of results. This is by far a common issue for the novice and the cause of this usually comes down to nerves. You see, no matter how disciplined they are with their trading on the simulated account, they ignore the fact that the trades are still not real and when real money is on the line, then emotions can easily get in the way. Usually the novice is not as confident about placing a trade as they were on the demo and ends up missing great opportunities due to a lack of confidence in pulling the trigger only to watch the market go off without them onboard. When they do finally place the orders, things then fall apart after a few losers and suddenly the tempo changes to the scenario of jumping in and out of the market recklessly in a desperate bid to claw back the draw-downs, resulting in far greater losses than were experienced in the safety of the demo account.
Even if you are an experienced trader and you have been back-testing a new strategy on the simulator with great success, you still need to be aware that when you are putting the rules to the test in a Live environment, there is the FX Dealer Spread which needs to be taken into account. Especially if your strategy is automated and executes during the quiet hours of the Asian session, spreads can become very wide when liquidity dries up, making profits much harder to attain. This is something which is not often factored into a back-test and you should not forget to account for a varying spread if you are such a trader.
Another issue commonly found with more experienced traders is that of the fear factor which pushes them back to the comfort zone of the simulated account. Things can be going well for a while on the live account, with a period of consistent and profitable trading becoming the norm. Only one day it all changes in the blink of an eye, with a confidence-shattering losing streak quickly hitting the emotions where they hurt most. The run of sustained losses forces the speculator to switch off the live account and move back to the safety of the demo world. Now understand this, I am by no means saying that is a bad thing to do and we should all enforce the discipline to halt our activities and assess our technique during losing streaks. However, this can also become a double-edged sword if we are not careful.
There is the danger of stepping away from the plan and trying out a few new ideas on the demo which we would not normally do, which in turn can be damaging to the original plan itself. We have to understand that no system will give winners all the time and the worst thing a trader can do is change the rules in mid flow. The demo can also lure the trader into a false sense of security. When they go back to the demo, the emotions are easily removed and just like the novice in the early stages, they will be using a transparent confidence when pulling the trigger. After a few winners on the simulated platform, they go back to the live arena and then suffer from an inability to allow the winning trades to fully run, taking small profits in an effort to get a feeling of relief because they are no longer a loser. But as we all know, small losses are part of the game and if we don’t counter these with larger average winners, then our trading runs the risk of stalling in the gates once again.
Like most things in life, there as always positives and negatives to anything we do and using demo accounts is just like anything else. My simple advice is to manage your expectations of what you are hoping to achieve from the simulator beforehand and use it as a tool to make progress in your trading journey. It is a key part of building your skills but will not be the only aspect you use. You still need to make sure you have a solid plan, that you have the right education and that you are testing your trading in the demo environment under the most realistic rules you can to keep things as realistic as you can, otherwise it may become a pointless exercise. Remember that it’s only real when it’s real after all.
Have a great week and again, Happy New Year.