Why You Should Use a Demo Trading Account

What Is a Demo Account?

A demo account, also known as a demonstration account, is an account that allows you to test drive the functionality of a platform without risking real capital. One Financial Markets provides a free demo account, with $10,000 in virtual funds, to allow you to get accustomed to the platform and to develop your trading skills without risk.

Most demo accounts allow you to execute trades in real-time and manage market-risk from your demo trades. The demo capital will also show you how much leverage is available when you make specific types of trades. In addition, you can test some of your trading strategies on the online forex demo account to see if they work.

Are There Benefits to Using a Demo Account?

There are several benefits to using a demo account before you begin to risk real capital. Becoming familiar with the trading platform seems obvious, but it is often overlooked. There is a difference between casually evaluating a platform and using the platform once you are executing trades and managing risk.

A demo account should allow you to execute trades in real-time and then manage the risk from those trades using real-time data. You should also be able to see a real-time demonstration of profit and loss as well as real-time balances.

Another very important reason to use a demo account is to test strategies. You want to test a strategy to determine if it will work using the parameters you have created. For example, if you have created a moving average crossover trading strategy, you can test to see if it works in real-time using real prices.  This is even more imperative for a scalping strategy since you are relying on small movements to capture gains. You can also see if the bid-offer spread that your broker uses will allow your strategy to work. You might quickly find that the spread or commissions eat into your profits.

How Does a Demo Account Work With Back-testing?

A demo account is an important part of back-testing. Back-testing is a process which allows you to see if your strategy has worked in the past. Once you have created criteria that have worked in the past and created sound risk management, your next step is to forward test. The demo account allows you to perform forward testing. This is the final step in the backtesting process. Your forward testing will allow you to determine if your back-tested criteria work going forward. If your back-tested criteria are too restrictive, and only work during the period you tested, you will discover this by using your demo account.

What Common Trading Mistakes Can a Trader Avoid by Using a Demo Account?

You want to avoid making common errors when you begin to trade your real-capital. A demo account can help you learn how to avoid some common trading mistakes. For example, novice traders will occasionally trade on the wrong side of the market, especially when they are trading the forex market.  It can be confusing when you are trading a currency pair to determine which currency you are buying and which one you are selling. A demo account will allow you to test your trade execution.

A demo account will also help you avoid trading without sound risk management. Many times, novice traders will focus on trade entry and profits and avoid considering a stop loss level before the trade is executed. By test driving using a demo account, you can avoid this common error.

Another mistake is exiting your trade before your stop loss level is reached. By testing your strategy on a demo account, you can avoid this situation.  A demo account will also help you avoid using a back-tested strategy were the criteria only works on a small period of time. By forward-testing using a demo account, you can avoid this situation.

Summary

A demo account is a real-time trading account that uses demo money instead of real capital. It will allow you to practice trading and avoid making some common trading errors. Many brokers provide a free demo account on different platforms including their downloadable platform, their web-based platform, and their mobile platform. Most importantly, a demo account allows you to practice and master your strategy before you risk real capital.

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