Did you know that the best traders all practice with paper money before putting any real money at risk? These practice or demo accounts allow novice investors to simulate the stock market experience by buying stocks and assets with fake cash.
Hence why they’re known as simulated accounts. Because you’re not using real money, you don’t lose anything.
Stock market trading with a demo account is ideal for learning how to trade for free and without any financial risk.
However, it doesn’t replace your need to develop the qualities that will make you a successful trade; discipline, humility and a calm disposition. Here are the main pros and cons of demo accounts.
The Benefits of Using a Demo Account
- Your learning curve is shortened.
Think of a stock trading simulator as a set of training wheels. It’ll help you perfect your game and strategy before the wheels come off. Then you’re set loose on the trading road. That’s not to say you won’t have bloody knees and empty pockets along the way. But, practicing in the simulator sure helps to keep the bloodletting to a minimum.
- The risks inherent in leverage are visible.
I’ve said this many times before and I’ll say it again; leverage is a double-edged sword. You can make lots of money quickly. But you can also lose everything in a bad trade. When trading in a simulator, you can sleep easy knowing a bad trade hasn’t gutted your account.
- It allows you to understand how the platform works and get a feel for the broker’s trading conditions.
In general, new traders need to nail two things. How to set up their charts for technical analysis and how to place proper orders based on their risk management criteria. The demo account is key to learn how to figure out the proper contract size and the margin used depending on the leverage.
- You get to nail your trading strategies.
Got a hot new strategy you want to try? With $100,000 in “pretend” capital, you can build a portfolio and test strategies without taking on any real risk. The fringe benefits include this; clean underwear (you’re not crapping your pants thinking about the trade), a house to live in (your wife didn’t kick you out because you were gambling), retirement savings untouched (you weren’t gambling).
With seamless and easy to read charts, our favorite trading platform to learn on is ThinkorSwim. With a deposit of $500 (for US citizens), their demo account offers quotes in real-time so you can train under real market conditions.
It’s is your chance to learn and analyze different chart setups, support/resistance lines, see how volatility impacts price action and practice your strategy.
Take our ThinkorSwim tutorial in order to learn how to set up your demo account and begin practice trading to go live.
In fact, check out our list of penny stocks that you can trade in your practice account. As a result, you can try out our watch lists ahead of time.
Make sure to take our free online trading courses for different ways to trade in our TOS account.
The Drawbacks of Using a Demo Account
- You develop a false sense of security.
Not all times but I suffice to say most of the time, new traders in a simulator don’t develop the healthy fear they need to succeed in trading. Even if you managed to make some money in a simulator, this doesn’t necessarily mean you will be a good trader.
Because when you have a controlled environment, your losses mean nothing. And unfortunately, the emotions related to losses and even profits have very little influence on your decisions. Losing $5,000, leveraged to $20,000, doesn’t have the same “impact” as it would in the real world; knowing that it was play money.
- Bad habit easily develop.
Bad habits can quickly develop because demo accounts can create a false sense of confidence. And with a false sense of confidence, traders generally have a hard time managing risk. Generally speaking, traders take more risks in a demo account than they usually would with real money.
- Your true colors don’t shine through.
Do you know how you will act when you are risking real money? Will you panic, and before the set-up has had a chance to play out? Or worse, are you a bag holder who fails to cut their losses quickly? Perhaps you pray the trade will turn around?
For the most part, the hardest thing to do when trading is not finding good entry points, but knowing when to get out. Once again, when emotions come into play, it is very easy to trade against logic and what your trading plan tells you to do.
Check out our real time stock alerts as another way to practice in a demo account.
There is no doubt that demo accounts are good. However, there’s just no way to replicate the real thing fully. Paper trading is an easy game to play; and one in which mistakes are quickly forgotten.
Because you’re not putting your money on the line, you won’t learn to control the highs and lows of emotion that go along with trading. It is much easier to throw down $10,000 on a high-risk penny stock than to buy it with your hard-earned cash.
What I am trying to say is that you also need real-world experience in the trading world to understand and control the emotional and psychological aspects of trading. With this in mind, I suggest you open your first real account with a relatively modest sum of money.
You need to physically experience the pain of losing and the full gauntlet of emotions associated with trading.
Why don’t you open a brokerage account and join us in our live trading room? You will have a chance to review your charts in real-time with our professional traders providing analysis. As the saying goes, practice makes perfect; come practice with us today!