"Since I'm killing it on my demo, I'm going to rock the house when I start trading with real money!"
At least that's what many new forex traders think.
But assuming that your success trading a demo will carry over into real trading, is like saying that you're going to date a hot model just because you're Mr. Stud on "The Sims."
It's wishful thinking, Mr. FX!
Trading currencies on a demo lacks a crucial variable: psychology – which kicks in only when the pressure of losing gets into a trader's head, playing all sorts of tricks with his mind (we will discuss trading psychology in depth on future blog posts).
In addition to psychology, demo trading also ignores two other important factors: liquidity and latency.
Liquidity on a Demo is Infinite
In the real world of trading Euros, Dollars, and Swiss Francs, the market has "depth."
That means that at any brokerage firm at any given time and for every given currency pair, there's a certain number of contracts or "lots" (aka, "liquidity") available for all clients to buy or sell.
Client orders are executed on a first-come-first-serve basis, so if too many clients want to buy at the same time and price and there's not enough inventory available, some clients will see their orders rejected. This is how the real market works.
On a demo, this is not the case.
Since the demo works in a simulated environment, it does't take liquidity into consideration and fills all client orders regardless of the size of their trades.
Liquidity risk becomes greater for active traders or scalpers, who open and close trades relatively quickly for only a few pips of profit. Consequently, FX scalpers might experience trade rejections a lot more frequently than longer term traders (read through our scalping section to learn more about scalpers).
Thus, when scalpers are trading on a demo platform using very large lot sizes, and assume that they will do the same on a real account, they are only deceiving themselves.
Latency on Simulated Trades
"Latency" is synonymous with "delay" and it is a part of every market, including foreign exchange.
When trading currencies, the latency is the amount of time it takes (after a trader clicks to place an order) for the signal to travel to the broker's computer, then to the liquidity providers (banks) the broker is connected to, back to the broker, and finally back to the client with an execution report.
Depending on the physical distance between the client and the brokerage firm, as well as the execution quality of the broker, the latency can be on average as little as a hundred milliseconds or less, or as high as a few seconds.
When using a simulator to trade FX, all orders are assumed filled when they reach the broker's demo server; so new traders tend to make the incorrect assumption that executions on a real account will be just as fast. Wrong!
The latency on a demo is lower than on a real account. This is something that Forex traders trying to graduate from the demo stage to real trading have to consider, especially scalpers whose bottom line is more adversely impacted by execution delays or latency.
So if you're a trader who's doing exceptionally well on your demo, don't assume that you're going to be God's gift to the trading world when you start trading real money.
Don't cry victory so quickly. You still have a long way to go!
Please leave us your comments below and tell us what your views are about demo versus real trading (feel free to request a demo here).