
Demo trading is a great way to get started in foreign exchange trading. It is identical to real trading, except that you're using "pretend" money. Demo trading allows you to get a taste for what type of events move markets and how they move. It encourages you to learn more about geopolitics, macroeconomics and global finance and these are all incredibly positive things.
Demo trading also introduces you to the rapture of greed. Trading is a means to one of the purest, most raw and potent forms of greed. The whole point of trading is to make money and the more money you make - the stronger the pull of your greed becomes. It is intoxicating and can take complete control of you.
But demo trading does not introduce you to fear. There is no fear when you are demo trading. It is like you have a perpetual get out of jail free card. If you start losing badly on a demo account - simply start a new one. There is no accountability for your trading failures and only recognition of your trading success.
So your demo account does not teach you how to handle the emotion of fear. This emotion is most likely going to lead to your downfall. Greed may get you overextended, but fear will stop you from cutting your losses. You may think that fear of losing money would cause you to cut your losses, but the stronger emotion is fear of being wrong and that causes you to hold on to your losing position - until it's all gone.
There is also the issue of account size. Many demo accounts give you $50,000 to play with. This type of capitalization allows you to buy 5 lots (500K) of EURUSD pretty easily. If goes up 20 pips you've made $1000. Nice one. But when you open your real account - it's more likely that you put $5000 or $10000 in there to begin with. Now you're dealing with a 50K lot, which means you'll take $100 out of a 20-pip movement. But mentally you are used to getting $1000 for that movement so you usually end up risking more. Next thing you know - your 200K position has turned against you 50 pips and you've lost $1000. That's real money you just lost. You can't just start another account.
The capitalization of the demo account is sufficient to sustain losses and still come out on top. But your real account is likely to be undercapitalized and if you're trying to achieve returns similar to what you got on your demo account - you are going to blow up very quickly.
Being honest with yourself
Ultimately, while providing an excellent introduction to FX trading - demo accounts do not accurately predict whether you'll be successful trading real money. Markets are dominated by psychology and often go against what fundamental logic or technical indicators suggest should happen. The single most critical factor in your trading success will be your ability to control your emotions of greed and fear. These emotions cloud your judgment and cause you to trade recklessly. Demo accounts introduce you to the emotion of greed, but by their very nature they are risk free and therefore there is no fear involved. They are also likely to be better capitalized than your real money account, which misleads you with respect to the amount of returns you can expect to earn.
For all of these reasons, demo accounts allow you to avoid being honest with yourself and this is perhaps the most important factor of all. You need to know your edge and your limits and in order to know these - you must be honest with yourself.
This being said, demo accounts are still very entertaining and educational and I highly recommend opening one to anyone who's interested in getting a taste of the exciting world of FX trading. It's a great way to learn more about economics, global politics and yourself.