To be useful, there should be no difference between real trading and demo trading. You should apply the same risk tolerance, the same vision, the same strategies as you would in a real account, should not trade a penny more than what you could trade forex in a real account, and take decisions as if the funds risked are as real as the sums in your bank account.
Many brokers give you a lot more virtual money than you could expect to commit if it were your own cash. This is to make sure that traders feel comfort while trading, but it also means that many traders trade with a much more relaxed, easygoing attitude than they would be doing with a smaller amount that is lost in easier manner. Since the trader is unlikely to be in possession of $50000 in risk capital to be committed in the currency market, for example, ten thousand lost in demo trading may not appear to be as real as it should be perceived. As a result, higher optimism, and a poorer comprehension of the risks inherent in trading arise, which then lead to a very poor performance with a real account, for easily understood reasons.
Demo trading is not a game, and if you don’t approach it with discipline, it may not be anything more than a marketing tool for the broker, leading you to be where you should not be in the first place. If you demo trade as if you were a millionaire with a large amount of cash to spread around and lose, it’s clear that the results will not be reflective of what you could achieve in real trading. Of course, as human beings we tend to overestimate our capabilities more often than not (and the trader’s mind is even more prone to this error) and demo trading without discipline and a conscious search for mistakes and misconceptions can easily be another ego-boost that only leads to faulty and unrealistic decisions in time.
It is also important to keep in mind that demo trading cannot be a substitute for real trading itself in any way. It is just a tool for testing the broker and yourself. Actual market conditions and liquidity constraints may lead to different degrees of slippage and misquotes in a real account than what is encountered while demo trading. Also, emotional pressures of demo trading usually have very little relationship to the experience of real trading, however small the actual amount committed may be.
To sum it up, demo trading is a great way to evaluate forex trading brokers, and an excellent way to learn about the market. It is not, however, a real subsitute for real trading, and no amount of success or confidence in demo trading can be expected to have a one-to-one correspondence with results in actual market conditions. Provided that it is used for the purpose that it was created for, namely, testing, and trial, it is a very useful too, but when used outside of its domain, it can even create harmful results for a long-term career.
More on the first step: using a forex demo account for technical analysis.
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