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As was briefly highlighted in the previous article about margin trading, trading is definitely a type of occupation that needs skill, practice, education, experience and much more. To help with that, most trading platforms or brokerages decided that they will allow their users, especially the new ones, to try their trading strategies with a method called demo trading.
Demo trading, also known as paper trading or market simulator, is an option for traders to use their chosen platform and trade on it without actually risking their money or capital. All of the trades are using fake capital provided by the platform, which means that the orders are not real. This also means that the orders do not affect the market as such.
Thanks to paper trading, no matter which asset class or financial asset, aspiring traders can test the market without the fear of losing money right from the beginning. Paper trading essentially came with the birth of online trading, since many platforms saw the potential to show the market behaviour to the traders before they truly started trading.
As the name suggests, paper trading is mostly helpful for traders. Having a demo trading account would in most cases not help investors, as the results would take much longer to show. The longer the time preference, the less visible the results in this case.
Traditionally, paper trading was mostly used for stocks, Forex and commodities. However, it has also become very popular with cryptocurrencies. Paper trading assets such as Bitcoin, Ethereum, Cardano or Solana can give much better experience about the movements of this young industry to aspiring traders.
Even skilled professionals, who were previously trading different asset classes, would definitely benefit from paper trading Bitcoin first before making the switch to trading cryptocurrencies,. This asset class moves very differently from others, despite the current correlation with the stock market. It has its own cycles that are dependent on different events, such as halving of Bitcoin.
One of the clear advantages of paper trading is to introduce newcomers to the trading world. As beginners, most people do not really know what to do when trading – for instance, how to execute the order correctly, when to enter or exit the market or which indicators to use.
That is what paper trading using a demo account helps with. Demo trading can also help with building, creating, testing or polishing trading strategy, which is needed if traders want to have consistent results. This also means that paper trading can also be useful for experienced traders who are either changing their strategy and want to test it or who are changing the asset classes they are trading and want to test their old strategies on that. This is very important as, for instance, Forex trades vastly different to crypto, which trades differently than commodities.
Paper trading also allows the user to get to know the platform they are using. This can help prevent mistakes, especially with the execution of trades and thus helps with protecting the overall trading portfolio from unnecessary losses. Most of these tools are usually also free, which means that it literally costs nothing to try the crypto trading strategies before actually jumping in.
Demo trading definitely has its pros, but there are also sides of it, which can be thought of as cons, since not everything is so peachy when it comes to trading fake money.
While paper trading does offer benefits of experiencing the financial markets, it does not provide the whole experience at all. Emotions are one of the crucial parts of trading and are also the element that paper trading excludes. Knowing that the trader is not actually losing money even if they had a losing trade is a very different feeling than seeing the red numbers on the screen when trading own funds.
Paper trading also allows for choosing the size of the traded portfolio. This means that the trader usually chooses a bigger portfolio size than they will actually use for trading, stopping them from learning the right ratios of entered positions, position sizes or stop losses and take profits. It also skews the expectation of what the monthly profit can be.
Demo trading on most platforms also excludes slippage from the demo trading accounts. This means that it allows for better execution than in real life, compromising the results that are actually attainable with the given strategy and execution. The absence of slippage is definitely one of the problems, but so is faster execution or easy entry and exit of positions.
Lastly, since the traders are not using real money, they are not earning anything if they trade their crypto with demo accounts. Yet, this also means that they are not losing any money, which is a purpose of demo accounts. As mentioned, demo accounts can help refine trading strategies and allow users to familiarise themselves with crypto trading without incurring any losses.
When it comes to cryptocurrencies, demo trading accounts have one more drawback that stands out more and that is the emotions’ part. While we have mentioned emotions before, cryptocurrencies are without any doubt the most emotionally affected market out there. FOMO (fear of missing out), FUD (fear, uncertainty, doubt) or hype are extremely powerful emotions which in real trading can cost huge damage. However, with paper trading crypto, it is very easy to resist the emotions that in the real world would drive the traders into irrational trading positions.
A lot of similarities and differences between demo trading and real trading have already been touched upon in the parts showing the pros and cons of paper trading. To bring all of this together, however, let’s look at the real difference between demo trading and real trading in a more complete picture.
While most of the time paper trading of crypto, or any other asset class, is free and offers mainly an experience of what it actually feels like to be trading, the results achieved by paper trading should be taken with a pinch of salt. The simulated results of paper trading rarely correlates with the real trading results.
On the contrary, it is very normal to see newcomers, who have seen a few weeks of successful paper trading coming to the real accounts and blowing them off fairly quickly. This is mostly due to the absence of emotions with paper trading, which in the real markets, have tremendous power over the trader if not handled correctly. The same can be said about money management, risk management or adhering to the chosen strategy.
Starting the trading journey in the cryptocurrency world with crypto paper trading is definitely a good choice. Yet, the newcomers to this world need to stay vigilant about the fact that promising results with demo trading accounts do not need to translate into good results with real accounts. That is one of the reasons why the traders should always start small with the real account, even after positive returns with paper trading, just to see how vastly different the real world of crypto trading is.
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