Nowadays, we get a lot of individuals who are experienced enough and want to dig into more advanced FOREX techniques but they do not really know where or what to start with.
In this article by Mib 700, we are going to talk about an advanced trading technique called “compounding”. But first, let’s see what compounding is. Compounding is a really great technique when you first start out trading with a small amount account. Usually, traders who trade like a thousand dollars love the compound. Anyone who trades ten thousand dollars or more really hates the compound. A lot of it has to do with aggressive swings, aggressive profits, and aggressive drawdowns. When you lose a thousand dollars it stinks but it’s not like losing ten thousand dollars.
Imagine you have an apple tree and it produces great apples. You have to make a decision: you can eat the apples or you can plant the apples. If you plant the apples, your apples will grow into more trees, and your trees will produce even more apples. And all this is making your money make money and even more money! So all this money you make is making more money. So, basically, this is compounding in a nutshell. The question when you want to eat your apples, when you plan to spend your money, and how many trees you want until sustainable. Because if you have a large account and you are a wealthy trader, you want to maintain that wealth and minimise the risks as much as possible.
According to Mib 700, you have to remember four key factors when creating the formula.
- Rist per trade
- Reward per trade
- Win percentage
- Production
Now let’s take an example. So, let’s say your risk per trade would be 2% that is a little aggressive. Your reward per trade will be 6%. Spend one dollar – make three dollars is a quite good risk/reward balance. Your win percentage is going to be 60%. You will win six out of every ten trades and expect to lose four. Your production is let’s say fifty trades per month. You have a thousand dollars available for investing. Let’s apply the formula to ten trades now:
10 trades, 6 wins at 6% = a gross profit of 36%
10 trades, 4 losses at 2% = a drawdown of -8%
The net gain is going to be 36%-8% = 28%.
Every ten trades equals a 28% growth, that is monstrous growth! So if you place fifty trades a month, it results in over one hundred percent growth! In other words, you will more than double your amount every month.
Now let’s suppose one month equals doubling your amount. It results in a total amount of two thousand dollars. Now, the second month, you take your two thousand dollars plus another two thousand dollars – four thousand dollars in total. The third month you will have eight thousand dollars, the fourth month you will have sixteen thousand dollars, and by your fifth month, you will have thirty-two thousand dollars. What you have to know is that this trend is not sustainable according to Mib 700. Fast up, fast down! Imagine you have one hundred thousand dollars instead. If you lose such a big amount of money, the situation will really turn into a nightmare for you! So, that’s why the compounding technique is way too risky to be applied with staggering amounts, higher than a few thousand dollars.
Hopefully, you find this short tutorial a good guide throughout your trading adventure and the method explained here will generate a great income for you if you apply it wisely.
