Compounding in trading
Compounding can help forex traders achieve exponential profits and account growth. Calculate your estimated forex profit for future periods of time. This will help you visualise long term projections and remain calm through times of psychological difficulties in trading. As we will discuss further, you can use our forex trading compound profit calculator to estimate your long term growth projections. This is one of our trading calculators you can utilise in your daily trading. We encourage you to also use our lot size calculator and stay on top of your risk management!
Compounding is the process that describes the increasing value of an asset due to the interest earned on both a principal and accumulated return. The principal value relates to the initial amount invested, which in the trading world is the deposit on your brokerage account. The accumulated return is the interest you have already earned on your principal. Compounding interest yields outstanding returns in the long run, which is why this notion is so critical in trading.
Principal and accumulated returns in the context of forex trading
As mentioned previously, in the world of forex trading the principal value is the quantity of funds deposited on your personal broker account. To make this easier to grasp for anyone not familiarized with compounding, we are going to inspect an example. If you deposit $30 000 in your trading account, this amount is your principal value. You trade on this account for a month, and you manage to achieve a 5% growth. For this first month, compound calculations are not applied. This is because the 5% growth is added only on your initial investment, namely the $ 30 000. This trading account now sits at $31 500;
[30 000 + (30 000 * 0.05) = 31 500].
Despite a positive growth during the first month, you decide to review your mistakes and reflect on your performance. You slightly refine your trading plan and manage to gain 10% in the second month. Because you did not withdraw any of the profits from before, the growth you experienced during your second month is $3 150. Check out the figure below to understand how accumulated returns help accelerate growth.
If you had withdrawn the profits of your first month, the growth would have been $3 000 instead of $3 150. It may not seem like a large difference, but the magic of compounding appears as more time passes.
Calculate forex profit
To calculate the potential return on your trading account over a certain period of time, you first need to select a compounding period. The compounding period is the time it takes for your trading account balance to grow by a certain proportion. Lets say you are confident in your ability to gain 5% every month you participate in the market. You can deduce your expected yearly earnings by multiplying the initial investment value by ‘1+r’ to the power of ‘t’. ‘R’ stands for the interest rate and ‘t’ refers to the number of compounding periods.If the account balance for this hypothetical example is $10 000, the expected balance after 12 months would be
$ 10 000 x 1.0512 = $17 958
In this example the account balance grew by almost 80% in a period of 12 months, which translates to $8000 of profit. If you would instead withdraw your 5% profit every month, you would have earned $6000 [12 x (0.05 x $10 000)]. In the latter example, simple interest is applied. The form of this calculation is adapted to forex trading in particular, but if you want to read more about compounding in general, feel free to visit this Forbes article.
Using our compound trading calculator
So far we have discussed the mechanics of compound calculations, and how they are specifically applied to the world of forex trading. It is nice to understand the technical side of simple computations like this, but nevertheless our compound profit calculator simplifies this process and saves you time. Firstly write your starting balance (principal value) on the designated box above. Secondly, select the compounding period frequency. We recommend using the monthly frequency in order to generate realistic and achievable long term forex trading profit forecasts. However, feel free to use the compounding period that fits best to your needs. Select the profit return per period (in percentage), and the number of compounding periods. This is all you need to do, and you will get numerical and visual projections of your capital growth based on your inputs.
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