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The Deadly Forex Demo Account

Brokers, in their never-ending attempt to entice new traders to their platforms, provide what they call "demo accounts" to anyone who's willing to drop their email address. Brokers do this officially to give new Forex traders a chance to become familiar with their trading account before depositing. Traders often use these while developing their systems, and they may go through dozens of the dummy accounts before graduating to the real article. Unfortunately, demo accounts aren't very useful if the goal is to become a better trader.

While a demo account uses the same data feed as the real McCoy and provides the same tools, it is a very poor facsimile for one all-important reason: emotions, or rather, the lack thereof. Live trading elicits strong emotions in practically everyone. These feelings, including greed, elation, terror, relief and elation, must be tempered with experience. Left unmanaged, they lead to carelessness, which results in an empty Forex account. Sadly, a demo account cannot cause these feelings in a new trader if they aren't risking anything.

The result of this is that profitable demo account traders will graduate to live trading with false confidence. When they take their first loss and are plunged into greed and fear, subtle subconscious changes to their trading style will set in. An ugly self-sustaining cycle can occur in which the trader continually reacts to these alien emotions by making bad trading choices, thus generating more negative feelings. Professional traders, in contrast, develop a barrier between their knee-jerk emotional reactions and their trading decisions through years of live trading.

Furthermore, using a demo account over a long time period can result in the development of two very bad habits: disregard for the stop loss and a focus on individual trades instead of proper money management. Most Forex experts agree that the stop loss is an essential component of a profitable trading method. Many demo traders, however, don't bother with a stop loss because they figure that they can close the trade manually at any time. In live market conditions, however, when actual money is on the line, such a casual attitude can result in huge losses in moments of inattention, especially during times of economic news releases when prices can plunge hundreds of pips in the span of a few minutes.

Because demo account traders don't care about their account balance, they're much more likely to focus on whether a particular trade was profitable or not. Yet in a live trading environment, the focus is on overall system performance and not individual trades. Variance and the law of averages will ensure that all systems experience drawdown from strings of losses, but a system with an edge guided by solid money management will bounce back. Demo accounts, however, over-emphasize the mechanics of trading, encouraging traders to disregard all-important concepts such as money management until it's too late.

New traders are advised to use a broker's demo account to become familiar with the features of the broker's software but to draw the line there. By the time a trader feels comfortable opening positions with the platform's one-click trading option ticked, they've mastered the software, and the demo account has served its purpose. To further test a system or gain trading experience, they need to experience the intense emotions that live trading generates. An economic middle ground may be the mini-accounts offered by most large brokers. Traders can open these accounts with as little as $50, and that's enough money to get the blood pumping.

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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.