The Magic of Compounding

They say it is the 8th wonder of the world, and I'd probably agree. It is the snowball affect where you have to have the patience in the early stages, to let the account build up slowly but surely. Eventually it will produce the desired results if you have a consistent profitable method and are willing to wait.

I still believe Oanda is a very good platform to trade with regards to using the compounding scenario. I did find if you nominated a certain percentage of your account to open a trade, the amount of units varied between pairs. This was obvious on the GBP. So I now just divide my account size by 333 each day and trade the unit size nominated. I'm not sure what one other poster stated about compounding being a double edged sword, as far as I am conerned, the position size varies with your account size, so if you are going backwards, then your position size should get smaller.

It is a great topic, and one where you can make a fortune if you are smart about it. It all comes down to patience, discipline and courage. Of course, we all know that! Cheers.

Hi Guys, I have the below article on my computer regarding compounding which I may use for myself so if anyone has any constructive opinions on it please share

Here is how it is done:
Start with $5000

5% of this is $250 so to find our number of lots to trade we do this. Take $250 and divide it by our maximum stop (40pips) which gives us 6.25. Round this number down to the nearest whole number and divide by 10 which gives us 6/10 or 0.6. This is the maximum number of lots we can trade with this balance. So how do we do this? When we open a position, we have to select the account number and enter the “amount.” Just enter .6 in the box. You are buying 6/10ths of a lot or 6 mini-lots. You can trade any number of these as long as the number is divisible by .1 in other words .1, .2, .3, 1.1, 1.2, 2.3, 2.4, 5.1 etc

So here is how we proceed. We are starting with .6 lots and $5000 so we know that the next number we can increase to is .7 lots. Now we do the math in reverse and we see that we need to have $5600 to trade .7 lots ((.7 x 10 x 40 pips)/.05). So we need to make $600 profit before we up our risk. Well at 20 pips per day, at $6 per pip (1 full lot pays $10 per pip) is $120 per day so it will take 5 days to increase our balance to $5600 unless of course we experience a loss between now and then, then it will take a few days longer. If you keep running these numbers out, you’ll see that your money doubles about every two months. On average, you should be able to profit 300-400 pips per month just trading one currency pair. If you regularly raise your number of lots as your balance increases, you will double your balance about every two months. Now keep in mind that it may take you a couple of months to get used to trading and get your psychology straight. If you are patient, it will come.
That’s compounding.

Very nice post. See, this is a lot more reasonable analysis. It takes into account the most important factor - money management. And it's frightening that even this is slightly optimistic.

So I can see now why 90% of people are losing money - they do not understand that they are all undercapitalized.


With this logic it means If you were to deposit $500 you can only trade 0.6 mini lots. That's $0.6 per pip. or $12 per good trading day.

And I'm sure there are tons of people that trade 5 mini lots with $500.

The beauty of compounding is that you don't need to high such a high % gain each month in order to gain high percentage gains. Compounding definitely gives you that extra edge in profits.

Mini accounts for anything under 20-30.000$ are the broker's way of setting you up to go bust, plain and simple. Anything below that amount needs micro sizing or you are severely overstaked on almost any imagineable timeframe.

I also believe that anyone using more than 2% risk is asking for distress either emotionally or financially.

I also want to post a compounding strategy that also puts money away safely. I for one was going to build compounding into my strategy because like you have stated it ends you in a very powerful position. Althought you dont have to compound 100% per say to make it effective example here(this is if you were able to double down per month according to the article):

month(cash) stash(money put away accumulative/added)
1 1000 ....................................................none
2 2000-200=180......................................200
3 3600-360= 3240 ...................................200+360= 560
4 6480-648= 5832 ...................................560+648=1188
5 11664-1166=10498 ..............................1166+1188=2354
6 20996-2099=18897 ..............................2354+2099=4453
7 37794-3779=34015 ..............................4453+3779=8232
8 68030-6803=61227 ..............................8232+6803=15035
9 122454-12245=110209 .........................15035+12245=27280
10 220418-22041=198377 .......................27280+22041=49321
11 396754-39675=357079 .......................49321+39675=88996
12 714158-71415=642743 .......................88996+71415=160411


In the end of your stash account you end with $160,411 give or take. Very nice but if you total it with your investment that is $803,154. Now this is better money management because lets say in month 9 you blow account. Your still left with $27,280 for a 8 month period. Of course this is a perfect world example that again goes by the standards of the OPs example. Obviously if you were to carry this strategy into a 2 year period you would have a serious stash and a serious investment fund.

Feel free to add your own percentages depending on how you manage your risk/reward. If you add more percentage at least you keep more and in the case if you do blow your account you've got that money.

very informative thread.

Seekinglight.... I'm not sure I follow how you have your setup but in user pref this is how mine is set.... so, as my balance grows so does my entry size.,,, thus compounding is achieved.

http://img20.imageshack.us/img20/102...enshot1nf0.png

any one thinking that the boss may gives 1 cent because he is stupid in the first day, and expect him work like hell in the last day? he may never survived for the next month.... (the more expensive your salary, more work expected)

i'll take that first day salary, better know it on the first day. and survived for the next month

Hi all,
I recently started a journal because I am trying to learn to add to positions without increasing my risk. After having read this thread http://www.forexfactory.com/showthread.php?t=62066
by Two blink, I started fiddling with the numbers in the triangle to see just how effective they can be.
So for example if I have determined that based on my account size I am willing to risk 250 dollars per trade, which means that with an sl of 50 I could trade 5 dollars a pip, I now use the Pascal triangle to determine what my position size will be to begin with, and how much I can add along the way. Using this method I can hold a position larger than 5 dollars a pip and risk less
The best thing to do is fiddle with the numbers and find out what suits you best..I have been using 84, 56, 28, 21, 15, 10, 6, 3, 1 for stops, and 28,21,15,10, 6, 1 for position sizing. On my last trade I was able to add to my position so that in the end I had 7.5 mini lots on, with less risk than had I put my usual 5 mini lots on from the start.

My last trade went like this: buy eur at 1.4700 2.8 mini lots, sl -84, max risk 84 x 2.8=$235.20
At 1.4728 I added 2.1 mini lots, which gave me an average position of 1.4712, and my sl moved to -56 deep from 1.4728 =1.4672, 40 pips below my new average position of 1.4712=maximum risk 4.9 x 40 pips=$196.00
I added 1.5 mini lots again 21 pips higher at 1.4749, so my average position moved to 1.4719 and my stop came up to -28 from 1.4749=1.4721 (now the trade is risk free)
At 1.4764 I added 1 more mini lot for a total of 7.4 minilots, my average position moved up to 1.4725 and my stop came up to -21 from 1.4764 so 1.4743, and I had 18 pips locked in..
As I didnt want to increase my position size at this point I just used the numbers to tell me when to move my stop, so 10 pips later I moved my stop to -15 below 1.4774, so 1.4759...and I left it there as I found it to be a support area I liked...
I like this method because it never made sense to me to open a position and hold the same risk all the way through, but I dont like the idea of taking profit and I want to be able to get as much out of a (possible) move as I can...
I found Two Blinks thread to be a great help and I am working the fibonacci numbers in the Pascals triangle into my trading with great success, so I hope it can be of help to others as well, take care, Raz

Indeed a shame Twoblink got that ban / the whole e-book incident happened.
He always had quite the interesting ideas and views, plus he had skills little others possessed.

After all he has contributed to FF, you would think they could have, I dont know, told him not to publicise the book on the forum again or something. I will really miss his posts...Raz

Does anyone know of a website that has a calculator that calculates the compounding daily % gains? I would like to know the possibilities of various compounding daily % gains with my trades.

Hi,

Compounding is a great effect. Even if you set a simple target like 5 pips, you could be a millionaire depending on rest of the parameters.

Then how come no one is a millionaire out of this scheme?

The reason is that you need four variables to control the math. One is your starting capital, next is your daily target pips, next is risk tolerance, and the last is stop loss. Without these, you dont know how much is at risk.

Lets say you start with $10,000. To stay in the trade, you need a decent stop loss. Lets say 20 pips. You also need to set an easy target so you can achieve it everyday. Lets say 10 pips. Then, you need to decide whats your risk tolerance - lets say 1%. This gives you a lot size of 10,000/100/20= 0.5 lots on day 1, and it will increase everyday as your profits add into your capital.

So you have all the parameters right. Now its easy to start imagining. Everyday you start collecting 10 pips and with these conditions, on the 365th day you would have made $61,746.53. Cool.

What happens when you lose a single trade? With your risk:reward parameters of 20:10, you need two consecutive trades just to go back to where you started. And you need a third winner to get the 10 pips you were looking for in the first place. So one losing trade requires 3 consecutive winners. If you have any one losing trade in these three trades, now you are now looking for 5 consective winners. And so forth. Its a snowball eating away your capital now.

And losing trades WILL happen.This is why although the idea of compounding is nice, its not a parctical one in Forex.

Oh, and btw, for those of you who are thinking why shoot for 10 pips, just shoot for 5 pips - its going to be even worse. With a Risk:Reward of 20:5, you will need 5 consecutive winners for 1 losing trade!

And for those who are thinking about using a smaller stop than 20, you will be losing trades by getting stopped out too often.

The only way you can beat this is to have a stop smaller than the target. Something like, 20 pip stop, and 40 pip target. But then, who can guarantee 40 pips a day?! Its a Catch 22!


So there is no way this idea is ever going to work, no matter how right your compounding calculator is. If someone could give you $x a day, and is ready to increase the amount everyday, thats when compounding will work the way we are imagining it.

JForex.

JForex78,

So if a 2:1 ratio won't work and a 1:2 ratio won't work, then is it wise to assume that a 1:1 ratio is the answer?

Keep going guys you almost have it. Consitancy, stops with space, multiple positions,compounding gains, certain losses, and randomness, are all apart of the grail your seeking. Your on the right path. If you find it, do us all a favour and DO NOT POST IT.

Let those who discover it reap the rewards. And for gods sake if you make a fortune give half of it back to something worthwhile.

Hi all, first post.

U need a sytem tht performs, and compunding takes care of the rest.

Lets just throw some numbers on the wall.

Lets assume u were to start trading on the first day of 2011 till the middle of 2017. Thts 6.5 years. U make say 10 trades a day, or 200 trades a month. Since ur an active day trader ur risk profile allows to say risk 0.2% on every trade, with comfort.

200 trades will yield say,

40 trades tht cancel each other out, (scratch, small losses small wins etc)

you have a balance of a 160 trades.

Ur R = 0.2%.

Lets say ur working with 3 million USD. (or $300, or $30,000 fwiw).

Ur per trade risk = $6000.

Now lets say u have a system tht yields a hit rate of approx 5/8.

So u have a 100 losses at a 100 R.

And 60 wins equalling

if r:r is 2.5:1, then 150 R

If u take slippage of say 15 R per month and commission of 10 R (seems bout right), then there is a net profit of

150R - 100R - 25R = 25R

Thats 5% per month.
If u take 60% as the yearly rate divided by 12
Compounded monthly yields approx 135 million USD.

Compunded quarterly (if u want to smooth ur position size changes), it yields
114 million USD.

Compounded daily yielded 147 million USD.

Notice the system expectancy is 12.5 %.
The expectunity (at 200 trades a month) is its power.
And the risk meter is low (0.2%).

Longer term traders can design systems with much better expectancy rates, to compensate for less trading oppurtunity, thus maintaining the same expectunity.

If we up the rate to 6% per month,

compunding quarterly u yield 222 million USD !! and compunding daily, 282 million USD !!!!!

what does this mean??? three important facts!


A) How u position size is extremely important, are u fast enough to compute ur risk exposure at all times and across all markets and trades (or have a system to do so) to compound (increase ur position) every month. i.e. does ur system allow u to realize ur expectancy every month or every quarter (this does not relate directly to compounding). What im saying is, r u confident enough in your system to expand ur position and let ur longer term (month crossover trades) take care of themselves???

B) EVEN MORE IMPORTANT

Ur risk to reward ratio is KEY. Noticge how even 2.75 to 1 in the above example , is a difference of a cool 150 million 7 years later!!!


c) What bout ur risk meter?

Certain short term postions might allow u 0.2% risk level, certain long term ones 0.5%. It all also depends in addition to ur system, to ur own tolerance.

For example,
maybe u see 10 - 15 losers in a row? but overall ur system is a winner. How would u like to be betting 1% a trade now?

15% drawdown???

i dont think so.....

On the other hand, maybe u have some strategy thts yielding u less longer losin streaks, so u can be more aggressive, up the ante to 0.4% or even a 1%



Also depends on ...... for ex, maybe u dont want to lose more then 5% a month. U shut down for the month, three losing months in a row u shut down for the year. (3 mos in a row, something is up)

U dont shut down and eat ice cream, u work on ur trades, u analyze ur streaks of winners and losers, u see ur slippage, shop for better commissions, redo the charts, WORK ON YOUR OWN HEAD, till u see the results for what they are

1) ur mistake
or
2) luck

then u return and resume. and trust ur system or tweak it, or change, but not b4 u knw whts wrong
So risk level is a function of a lot of things, and to arbitarily pull out 1% or 0.2% for tht matter is an injustice to trading.

Also statistical reference has to berespected with regards to Risk of ruin, but we all know tht. (I ask ppl who havent already to read Ralph Vince on this, he is an authority, although impractical at times, his theory is excellent)

And for the gentleman who mentioned tht the losses will catch up in the trading month? A positive expectancy system is positive period (if formulated,tested and executed properly) it takes into acct so many losers in a row etc.


Well, if u have a robust system, backtested soundly, proven in live markets for yourself, good understanding of expectancy and position sizing along with the very important psychology and discipiline required to do this 20 days a month for 6 and a half years?

Sure, compunding will come into effect, and will come in a big way.

But thts also assuming u have 3 million stashed away tht u dont need to touch for six and a half years. But then again, 3 million is not the point, is it?


Look, all these numbers are not important, whats important are the concepts of, discipiline and hard work combined with sound position sizing, records and prepration.

Book the trades, the compunding will take care of itself.

I apologise for the haphazard writing, but ill try and get better. Long time lurker.

I can see the amazing cumulative powers of compounding, for example a 10K account @ 2% per trading day and in six months you'll get a million (and 2% daily is an easy feat).

But how realistic is this since I don't know one person who has done it? (my circle don't include many traders)

I'm still practicing trading since I blew my account before so I'm not rushing things at the moment, but right now I'm practicing and practicing on a live micro account until the day I'm ready to put my savings into gear. Hopefully this compounding things is not a myth

2% per day an easy feat? Sustained over a long time, I assure you, 2% per day is a Herculean feat.

Yup....Buffett would try 2% a month...