Most CFD brokers provide demo accounts for new customers, and many CFD traders see this as a huge advantage. Both brand-new traders and more experienced traders experimenting with a new platform will eagerly sign up for a demo account to practice trading with virtual money and perfect their trading strategies before they invest any real capital.
Many experienced traders will agree that a demo account is a good way to learn how to trade, find your way around a new trading platform and try out new trading strategies. They will also warn that even though most demo accounts claim to perfectly mimic the real trading experience that the broker provides, this may not be entirely accurate.
A demo account is basically a computerised simulator. Like any simulator, it allows for training and practice to take place in a safe environment. Your demo account loads up with virtual money, often a substantial amount of it. You use this virtual money to place trades, enter and exit positions, test out tools and strategies and make virtual profits and losses. The demo account represents exactly what is happening in the markets in real time, so in theory, the gains and losses that you make with a demo account are the same as you would make with a real account. Or are they?
Every day trader upgrades from a demo account to a live account, encouraged by the profitable trades that they made or even frustrated about making all this potential profit that is, of course, not real. They are understandably eager to start playing with real money and making a real profit. After upgrading, they are often shocked to find that their successful demo trades are not as easy to replicate as they thought. There are a few reasons for this.
In fact, the execution on a demo account is usually slightly better than in live trading. This sounds like an advantage, but what it means in practice is that when you place an order on a demo account, the order will always fill at the price that you expect. In a live market, orders are subject to slippage, when the price of an asset moves slightly and the trade or part of the trade with a large order executes at a different price than the one showing on the screen when you place the order. This is particularly likely to happen in times of very high volatility. Some brokers will guarantee that making your order at the price showing guards against slippage, but most will not.
Another practical problem with demo accounts is that they may not reflect the fact that with a live account, bids and offers go into a queue. Again, an order may occur at a different price than the one shown because only a limited number of shares are available at that price. On a demo account, you will place the order immediately, and the price that you see is that price you get.
Demo accounts typically provide at least $10,000 or £10,000 of virtual money, which does not accurately represent the size of the account that most new traders will, or should, start with. Demo software generally allows traders to choose the amount that they trade with, but it is tempting to take the full amount and see what you can do with it, which is exactly what a lot of traders do.
Trading with high amounts of virtual capital is unrealistic and can lull traders into a false sense of security. With high capital, small losses are a tiny percentage of the overall account, and with a real account, the same loss might represent a much higher proportion of the total capital. Traders may face the temptation to trade higher-price assets that they cannot afford in real life. Those who do well with generously funded demo accounts may be tempted to use maximum leverage in order to trade with a similar amount in their live accounts, and as we have said, trading with high leverage is not a good idea for inexperienced traders.
The most important aspect of demo account trading may be the most obvious one. The money is not real, and trading with virtual money will never simulate the same emotions as trading with your own hard-earned and much-needed capital. When fear, hope and greed kick in, traders make bad decisions, which simply does not happen when you are practising with virtual money. Most traders make better, more logical and more disciplined decisions when trading with a demo account simply because they have no emotional connection to the virtual money.
Learn about order execution and factor the differences between demo accounts and live accounts into your overall results. In your own mind, at least, account for slippage and the fact that your orders may not fill at the stated price. You could also consider opening your live account with one of the few brokers who guard against slippage by guaranteeing that you can place your orders at the stated price without risk.
If the demo software allows this, then reduce the amount of capital to the amount that you will be trading within your live account, and remember to factor in sensible leverage. This will give you a realistic overview of what gains and losses will actually mean in percentage terms, given your original investment.
Try to simulate the emotions that you will feel when the money is real. The demo account cannot do this, but you may be able to. Make a concentrated attempt to imagine that you are trading with real money. This is actually easier to do if you set the amount of virtual money to the same amount that you will be using in your live account.