Go Live White Paper

Fan Yang is a registered CTA and is currently working to complete his CMT-designation. As one of two instructors in the firm’s educational webinars, Fan encourages students to use demo accounts when practicing the tools and principles taught in the course. Recognizing that there is an apparent discrepancy between demo and live trading results, he addresses what he believes are the main factors behind these differences in hopes of helping traders correctly utilize their demo accounts and prepare for live trading.

Preparing For the Transition from Demo to Live Trading

Demo accounts offer an invaluable opportunity to sharpen trading skills. However, there is a resounding agreement that demo and live trading are completely different animals. Many complain that their successful performances in demo do not carry over to live trading, and that demo trading does not prepare you for live trading. This warrants careful consideration of the factors causing the discrepancy between demo and live trading. Understanding these factors may help with two things: 1) How to fully utilize the demo account 2) How to make a transition to a live account. Let’s examine these factors and how we can deal with them.

During Demo (execution and simulated conditions):

1. Execution

FACT: Demo accounts automate all execution while live accounts automate up to 10 lots for certain currency pairs at CMS Forex. A disclaimer for demo accounts states “Simulated conditions may differ from real conditions, and traders should not necessarily expect the same results from live trading.” Let’s say the market is very volatile after a certain Non-Farm Payroll release. You request a price in a trade order. A demo account would execute the price requested. However in live trading, the broker then tries to execute this price with the bank that feeds it streaming quotes. By this time, which can be within a second, the price is no longer available. In this situation, slippage occurs when the broker executes your order at a price that is NOT within a pre-specified and acceptable “trader’s range”. However, there is no slippage¹ on market orders at CMS Forex because orders for unavailable prices are re-quoted with the next available price. Nonetheless, with any broker, your entry points in the market under live trading conditions may at times be significantly different from those made under the demo environment.

Issue and Resolution: The issue is that LIVE trading will always incur higher transaction costs than reflected by demo trading results. Accepting this fact, the trader should then incorporate higher costs during the evaluation of his or her demo performance in preparation for live trading. For example, round down simulated winnings to the nearest 10 pips, while rounding up losers. Let’s take a hypothetical case, where a trader’s strategy has yielded these results: +67 pips, +48 pips, -38, +82, +45, - 38, resulting in a net of +166 pips. The trader could then round these appropriately to: +60 pips, +40 pips, -40, +80, +40, -40 = resulting in a net of +140 pips, a difference of 26 pips in the 6 recorded trades Let’s take a look at another example. Let’s say Bob has results +15, -72, +28, - 56, - 62, +5 = -142 pips. With the same adjustment approach, his live performance would be estimated with, +10, -80, +20, -60, -70, 0 = -180. A dramatic difference to the downside of 38 pips. Essentially whether the net result is positive, negative or flat the results should be adjusted to reflect the higher cost of gains and losses. Should this trader’s system place trades frequently at fast market situations, he or she may want to shave even more from demo results, ie. an additional -5 pips for each trade after the rounding. On the other hand, if the system places trades in relatively calmer markets, this rounding method may already be appropriately conservative. There are many other techniques you can use, but just remember that the higher number trades you make, the more cost adjustment you will have to make. Also note that the example only used 6 results for the sake of simplicity. 20 is the minimum statistically valid sample size, and you may want to use more.

2. Simulated Conditions

FACT: First of all, the whole purpose of a demo account is to 1) get familiar with the trading platform and 2) practice strategies and building trading plans. The first purpose is usually fulfilled without issues, but some traders fail to control their demo environment to replicate their live environment.

Issues and Resolutions:

The first discrepancy made by many eager beginner traders is the use of inappropriate amount in demo trading. This defeats the purpose of preparing for live trading. Trading plans should involve a money management aspect, and the amount in your equity is an important variable. Therefore, it is important to use an amount in demo that is likely to be used in live trading. On top of that, the amount you plan to use should not affect your lifestyle significantly if lost – limiting emotional extremes (we will get to this soon)
Another discrepancy is in the time spent on trading, and just as importantly, time NOT spent on trading. You should keep this in mind with any back-tested results, unless your trading system is completely automated. This is because many signals may be generated during odd hours, where you normally can’t trade. If you incorporate results from these trades in demo performance, you better be prepared to stay up during these odd hours if you are aiming to replicate your performance.

During Live (emotions, psychology):

Having prepared for the difference in execution between live and demo, you will now have to face the enemies from within.

3. Real Money vs. Fake Money

FACT: The emotional attachment to an account balance or to a change in the balance is completely related to whether that amount is real or demo.

Issue and Resolution: If you have never traded live, there is no way to know for certain how emotions will affect you. A possible measure to take is to limit your initial trading sizes. This is analogous to testing the waters by dipping your toe in the pool first. Also, only use your risk capital, which you are not dependent on.

4. Emotions

FACT: Emotions tend to change performance results.

Issues and Resolutions: Despite trying to limit emotions, we are all human and cannot escape them. When you switch from a mock account to trading with real money, expect a sensation in your gut. There are a few approaches you can subscribe to in dealing with emotional factors. 1) Make your trading plan as mechanical as possible. 2) Understand the dynamics of your trading when emotions overwhelm you. 3) Adopt “warrior/philosopher” psychology.

In having a trading plan that has a strict set of rules, you are attempting to leave emotions out of trading. The most extreme example is a purely mechanical trading system, which does not even require the trader to be there when trades are opened and closed. More likely though, you may want to reserve the final decision making for yourself as a filter of signals. But even in this case, you should have a set of rules to follow.
Although, you won’t know exactly how it feels to trade live until you do so, you can anticipate how these emotions will affect your trading. Listed below are a set of emotions traders commonly face. Understanding which ones are your Achilles heel(s) may help you prepare against it. For example, you may find in retrospect that a certain trade was hurried and was not made according to your tested plan. You will want to analyze the events in the market or even in your life which led to this mistake. Next time these events line themselves up, you will have your guard up and be prepared to fight or restrain your emotion.
The “warrior/philosopher” mentality refers to a detachment of emotions to the results. If you are able to pin point specific kinds of situations which invoke specific types of emotions, you can be one step ahead in trying to detach yourself from them. Thus like an observant philosopher, you can reasonably attribute the factors that lead to failure. If they are by nature a part of your system, you can either accept them as “operational cost/risk”, or re-evaluate your trading plan. Remember the saying that “the market is always right”. You can’t blame the market if a certain trade goes wrong. Take accountability and strategize on improving.

Common Trading Emotions: Emotions are most apparent when trading live, and with an amount that is significant to your lifestyle. These are emotions you need to keep in check. Treat them like enemies to your trading plan and drive them out.

Fear (Fear of not being able to support yourself, family etc.) – This fear may be limited if the trading capital is not significant to overall lifestyle. However, anytime there is a risk, fear is around the corner. This may cause you to deviate from your original plan, or shake your execution of the plan. Having confidence in your existing trading plan is important to conquer this fear. If you have tested your strategies, and use an appropriate trading size, you may be able to remove this fear, or at least not let it prevent you from executing your plan.
Greed – There is a basic degree of greed that is natural. However, certain market situations may cause that greed to affect trading decisions. Let’s say your money management rules in your trading plan set a limit of 20% maximum drawdown (amount of loss compared to your total equity in the worst stretch). Now for example, let’s hypothesize that this effectively limits your acceptable exposure to be 3 lots at anytime. Now seeing a beautiful setup, and in a moment of greed, you open 6 lots. Now, you are no longer following your money management rules and potentially risking twice as much. When you see many setups at once, don’t be greedy and try to pick them all up. If you do, make sure you size each trade so that they aggregate to an appropriate exposure.
Euphoria – When the extra greed leads to undisciplined trades and sometimes yielding positive results, you may become overly joyous, like nothing in the world can go wrong. This tends to be the exact point of trouble because the disciplined process of analysis and decision making goes out the door. Negligence in using disciplined analysis (and at times arbitrary addition of untested analysis), improper position sizing, and failure to set stops and limits are all common practices during euphoria. At no time should you feel it acceptable to skip the steps in your tested strategies. Therefore, when the market goes in your direction the moment you open a position, take a deep breath, and try not to get excited. It is just another trade, and you have many more to go.
Desperation – You win some you lose some. Many beginning and even seasoned traders fall in the trap of trying to make back what they lost. This is a desperation move to hold on to a certain equity level, or maintain a certain profit-loss ratio. The main cure for this is to treat each trading decision separately. A previous winner or loser should NOT affect the current decision (except in position size). This also requires you to accept the fact that there will be losers, as long as these losers are part of your trading plan, and not due to emotion-induced decisions. Again, applying the warrior/philosopher mentality, you may be able to treat each trade differently. Treat each trade with care, and do not let these emotions be any part of your trading decisions.

¹Under normal market conditions CMS Forex honors the price on stop and limit orders up to 10 lots for specific currency pairs.

Disclaimer: Trading OTC Forex on margin carries a high level of risk, and may not be suitable for all investors. The high degree of leverage can work against you as well as for you. Before deciding to invest in foreign exchange or futures you should carefully consider your investment objectives, level of experience, and risk appetite. The possibility exists that you could sustain a loss of some or all of your initial investment and therefore you should not invest money that you cannot afford to lose. You should be aware of all the risks associated with foreign exchange and futures trading, and seek advice from an independent financial advisor if you have any doubts.

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GOING LIVE: Transitioning from Demo to Live Trading | Whitepaper by Fan Yang

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Preparing For the Transition from Demo to Live Trading

During Demo (execution and simulated conditions):

During Live (emotions, psychology):