Why Demo Account Performance Is Often Better Than Real Account Performance

Home
>
Currency Trading
>
Why Demo Account Performance Is Often Better Than Real Account Performance

Why Demo Account Performance Is Often Better Than Real Account Performance

Over the past several years, the popularity of online currency trading has grown substantially. Each day, online FX brokerage firms attract new investors - each of them lining up with a glint in their eye, lured in by promises of easy money. Most of these companies allow you to sign up for a free demo account which lets you place mock trades using their trading platform to get a feel for the excitement of currency trading. In the casual world of free demo accounts - many young traders find they are able to garner impressive profits without a significant amount of effort. It almost seems too good to be true. But transferring this success from a demo account to a real account is far less common. Why is this? The actual trading platform behaves the exact same way, the market doesn't care whether you're a demo or real trader - so what is different? It's you who has changed. Not your personality, not even your trading style - but the factors that affect you are different.

What is the key factor to trading success?

The search for the "Holy Grail" of trading has been a common theme throughout the history of markets. There are a variety of different techniques. Those whom are inclined towards number crunching and pattern recognition may prefer technical analysis, whereas those more focused on the big picture, logical macro perspective prefer fundamental analysis. Then there are specific methodologies like swing trading, trend following or even more esoteric ideas like the Elliot Wave theory. Which one is best? There are examples of very successful traders using each methodology.

Since most new traders lose money - perhaps the more appropriate question to ask is, "What is the key factor to trading failure?"

Greed and Fear

Trading is an atmosphere rich in the porous emotions of greed and fear. The current price of a given security or financial instrument at any point in time can be thought of as the confluence of greed (bulls) and fear (bears). These two emotions make up the core of humanity itself. When market information is released, trading can be a high intensity experience. Sensing danger, your body releases adrenaline that acts to accentuate both your greed (fight) and your fear (flight). Because these emotions are so strong, they can cause you to act irrationally, ignore your system, stated set of rules or trading plan and to act upon impulse. Indeed, this is a genetically programmed response - but it is often also the trader's downfall, especially when he's playing with much better capitalized, more sophisticated and experienced foes that know how to manipulate those emotions.

When you are a trader - you are always under the influence of at least one of these two emotions, even if you don't have any trades on.

Impact of fear and greed on your trading

If the market's going up and you're in - greed is telling you to buy more and fear is telling you to take your profits while you still can. If it's going down, fear of being wrong makes you hold onto a losing position - and then greed sometimes convinces you to "average down" your position (and buy more) so it'll be easier for you to come back.

If the market's going up and you're not invested - fear is telling you that you're missing out on easy money but it's your greed that causes you to get in just after the greatest increase (just when its about to reverse course). If the market's going down and you're not invested - greed is telling you to get in as the price is cheap, while fear reminds you that you'll miss out on this opportunity if you don't act quickly.

Perhaps if we just felt greed, or just felt fear we would be able to control our emotions a little better. But when both of these little devils whisper into our ears at the same time - it is often impossible not to listen.

The Thrill of Greed

The first time you try FX trading - you will feel the thrill of greed. It is an ecstatic experience, your brain flush with neurotransmitters and your mind giddy with visions of untold riches about to be reaped. Greed is bold, aggressive and incredibly exciting. It can take hold of you both mentally and physically. Just imagine the possibilities!

This greed is what draws us into FX trading in the first place - the dream of easy money and 100:1 or 200:1 margin rates. It inspires us and causes us to forego rational thinking in favour of reckless abandon.

In the movie Wall Street, Gordon Gecko says, "Greed is good", but it is also very dangerous - especially if you are unable to recognize when greed is the one doing the talking. Greed is also one of the most common techniques used to manipulate people. Every get rich quick scheme, promising untold riches for no money down takes advantage of your natural predisposition to throw all logic and sense out the window when greed pays a visit. The argument starts to appear very compelling and you ignore what would otherwise be clear warning signs. Like drunk goggles, greed can mislead you and when you eventually wake up you are often in a very precarious position.

The Fear of Losing

Fear can be equally as dangerous. The most potent and easily manipulated form of fear is your fear of admitting that you are wrong. Fear of having your precious ego bruised. This fear can cause people to do incredibly stupid things. The funny thing about this world is that everyone thinks that they are right. Most people would rather lose thousands of dollars than admit they are wrong. It is easy to feel ashamed of trading losses and live in denial but this is self-destructive behaviour. By denying the problem exists, you fail to take steps address it and only ensure that it will continue in the future.

Demo Trading

Demo trading is a great way to get started in foreign exchange trading. It is identical to real trading, except that you're using "pretend" money. Demo trading allows you to get a taste for what type of events move markets and how they move. It encourages you to learn more about geopolitics, macroeconomics and global finance and these are all incredibly positive things.

Demo trading also introduces you to the rapture of greed. Trading is a means to one of the purest, most raw and potent forms of greed. The whole point of trading is to make money and the more money you make - the stronger the pull of your greed becomes. It is intoxicating and can take complete control of you.

But demo trading does not introduce you to fear. There is no fear when you are demo trading. It is like you have a perpetual get out of jail free card. If you start losing badly on a demo account - simply start a new one. There is no accountability for your trading failures and only recognition of your trading success.

So your demo account does not teach you how to handle the emotion of fear. This emotion is most likely going to lead to your downfall. Greed may get you overextended, but fear will stop you from cutting your losses. You may think that fear of losing money would cause you to cut your losses, but the stronger emotion is fear of being wrong and that causes you to hold on to your losing position - until it's all gone.

There is also the issue of account size. Many demo accounts give you $50,000 to play with. This type of capitalization allows you to buy 5 lots (500K) of EURUSD pretty easily. If goes up 20 pips you've made $1000. Nice one. But when you open your real account - it's more likely that you put $5000 or $10000 in there to begin with. Now you're dealing with a 50K lot, which means you'll take $100 out of a 20-pip movement. But mentally you are used to getting $1000 for that movement so you usually end up risking more. Next thing you know - your 200K position has turned against you 50 pips and you've lost $1000. That's real money you just lost. You can't just start another account.

The capitalization of the demo account is sufficient to sustain losses and still come out on top. But your real account is likely to be undercapitalized and if you're trying to achieve returns similar to what you got on your demo account - you are going to blow up very quickly.

Being honest with yourself

Ultimately, while providing an excellent introduction to FX trading - demo accounts do not accurately predict whether you'll be successful trading real money. Markets are dominated by psychology and often go against what fundamental logic or technical indicators suggest should happen. The single most critical factor in your trading success will be your ability to control your emotions of greed and fear. These emotions cloud your judgment and cause you to trade recklessly. Demo accounts introduce you to the emotion of greed, but by their very nature they are risk free and therefore there is no fear involved. They are also likely to be better capitalized than your real money account, which misleads you with respect to the amount of returns you can expect to earn.

For all of these reasons, demo accounts allow you to avoid being honest with yourself and this is perhaps the most important factor of all. You need to know your edge and your limits and in order to know these - you must be honest with yourself.

This being said, demo accounts are still very entertaining and educational and I highly recommend opening one to anyone who's interested in getting a taste of the exciting world of FX trading. It's a great way to learn more about economics, global politics and yourself.

William White is a software developer and avid foreign exchange enthusiast.

His website - Finance Maps offers free maps depicting short, medium and long range trends for the major currency pairs which allows the reader to easily get an overall sense of the global forex markets in a single glance.

In The News:

Yahoo! News: Top Stories

Atty. Gen. Mukasey collapses during speech (AP)

AP - Attorney General Michael Mukasey was hospitalized but conscious and alert early Friday after collapsing during a late-night speech to a conservative legal group.

Obama plans to nominate Clinton for top diplomat (AP)

AP - President-elect Barack Obama plans to nominate Hillary Rodham Clinton as secretary of state after Thanksgiving, a new milestone for the former first lady and a convergence of two political forces who fought hard for the presidency.

Congress sends jobless benefit extension to Bush (AP)

AP - With no end in sight to economic bad news, President George W. Bush is about to ensure that millions of laid-off workers won't see their unemployment checks disappear as the year-end holidays approach.

European, Asian markets rebound despite US losses (AP)

AP - European and Asian stock markets rebounded Friday as expectations of a recovery on Wall Street prompted investors to scoop up battered financial and energy shares.

Neb. lawmakers form task force on child drop-offs (AP)

AP - Lawmakers are poised to close a loophole that led to troubled teens being abandoned at Nebraska hospitals, but they aren't stopping there. Instead, they're vowing to make sure families can get help in a crisis.

US details role for additional Afghan forces (AP)

AP - With the United States reevaluating strategy in Afghanistan, Defense Secretary Robert Gates is telling allies that additional U.S. forces planned for the war must be shared across the region taking the brunt of the fighting.

Report says CIA withheld info from White House (AP)

AP - The CIA withheld information from the White House, Justice Department and Congress about the 2001 shooting down of a plane over Peru carrying an American missionary family, part of a yearslong cover-up of lethal violations in U.S. drug-interdiction procedures, according to a classified internal CIA report.

Madonna, Ritchie granted preliminary divorce (AP)

AP - Madonna and Guy Ritchie were granted a preliminary decree of divorce Friday.

Man says cell phone saved him from stray bullet (AP)

AP - R.J. Richard says he doesn't normally put his cell phone in his chest pocket. But he says it saved his life the one time he did.

Steelers defense controls Bengals in 27-10 win (AP)

AP - Ben Roethlisberger and the Pittsburgh Steelers know exactly how to beat the Cincinnati Bengals Â— with or without Chad Ocho Cinco.

Central bankers wary of deflation (Reuters)

Reuters - Euro zone demand is plunging and price pressures vanishing, business surveys showed on Friday, while central bankers weighed the bleak prospect of deflation.

Obama on track to name Clinton as top diplomat (Reuters)

Reuters - Retired Marine Gen. James Jones emerged as a leading contender for White House national security adviser as President-elect Barack Obama worked on Thursday to assemble his foreign policy team.

Bush takes financial reform agenda to APEC forum (Reuters)

Reuters - George W. Bush makes his last scheduled trip abroad as U.S. president on Friday, heading to an Asia-Pacific summit where he will seek support for global financial reform and hold talks on ending North Korea's nuclear program.

Thousands protest in Iraq against U.S. troops pact (Reuters)

Reuters - Followers of Shi'ite cleric Moqtada al-Sadr marched Friday against a pact letting U.S. forces stay in Iraq until 2011, toppling an effigy of President George W. Bush where U.S. troops once tore down a statue of Saddam Hussein.

Citigroup eyes options, including merger (Reuters)

Reuters - Citigroup Inc lost more than one-quarter of its market value on growing worries over whether it has enough capital to withstand billions of dollars of potential losses and despite new support from its largest individual investor.

Verizon staff had unauthorized access to Obama's cell (Reuters)

Reuters - Verizon Wireless said on Thursday that some employees had gained unauthorized access and viewed a personal cell phone account held by President-elect Barack Obama that is now inactive.

Attorney General Mukasey vital signs strong after collapse (Reuters)

Reuters - U.S. Attorney General Michael Mukasey was "conscious, conversant and alert" at a local Washington hospital after collapsing while delivering a national security speech at a hotel, the U.S. Justice Department said late on Thursday.

U.S. Navy says no word on Somali pirate ransom demand (Reuters)

Reuters - The U.S. Navy and operators of a Saudi oil supertanker hijacked by Somali pirates could not confirm on Friday reports that the hijackers had demanded a $25 million ransom.

Use of nuclear weapons more likely in future: US intelligence (AFP)

AFP - The use of nuclear weapons will grow increasingly likely by 2025, according to a bleak US intelligence report that warns that US global dominance is likely to weaken over the next two decades.

Thousands of Sadrists protest Iraq-US military pact (AFP)

AFP - Thousands of mostly Shiite followers of the firebrand anti-American cleric Moqtada al-Sadr gathered in Baghdad Friday to protest a security accord that would allow US troops to remain until 2011.

Why Demo Account Performance Is Often Better Than Real Account Performance

Currency Trading Currency Trading