Trading is about making money, otherwise nobody would be doing it. Well, maybe few purists would still engage in the process for the “challenge”, but they are in a minority. Most of market participants seek profits. Generally it is accomplished through creating winning strategies. This process is being constantly improved and refined in a pursuit of ever better method, which, logically, should lead to increased returns. Productive systems are necessary in order to have positive outcome to trading, but once that is accomplished, other steps can be taken in order to maximize total return on our trading capital. One of them is compounding.
What is compounding? Investopedia defines it as “The ability of an asset to generate earnings, which are then reinvested in order to generate their own earnings. In other words, compounding refers to generating earnings from previous earnings”. Most people are familiar with in concept when it comes to mutual funds or 401K investments. Money earned in these instruments is typically left in them, to be reinvested by managers. Passive application of this principle, when an average investor leaves the compounding to others. However, active traders, including most Forex market participants, should do it in their trading account, and on regular bases.
In a simplest form, compounding would involve increasing trading size as soon as account value makes new high. Concept is easily implementable while trading stocks, because one could buy, or short sell, any odd number of shares that account size allows. Doing it in currencies is a little more complicated, however, due to lot size and difference in offerings form broker to broker. Vast majority of retail traders have to use leverage to some degree in order to trade standard size lots. This has to be taken into consideration when planning how compounding should be employed in one’s account.
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12-01-09, 08:23 PM
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