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Compounding a Forex Account

compounding risk mamangement

A Simple Yet Safe Way For Portfolio Growth

The goal of many forex traders is to build a consistent and stable structure which will bring the most return on investments. One of the most effective ways to grow your forex trading account, is to build a program in which every time you make a profit, you add the profit to your investment portfolio. By doing so, even the most modest of accounts can see exponential growth as opposed to the modest increases had the account only relied on making the same investments every time which would result in slow, linear growth.

Compounding: Adding The Recent Profits On To The Next Investment.

In this article we’ll lay out a few ways to create a structure which will enable you to reach exponential returns. As always, while we can lay out tips, tools, and tricks, it’s ultimately up to you whether or not it’s a system that’s right for you and your current skill level. If you think you’re ready, get set because compounding is all about being profitable.

However, while you’re profitable in the midst of compounding your trades, it’s important to understand how your profits were made. This implies and means that there are many different ways to create profit but for the purposes of compounding, you should be having profit by a systematic method.

For example, let’s briefly touch on a theoretical method that wouldn’t co-exist with compounding. Say you have a system which every time you have a losing trade, you add on the next trade while expecting to compensate for the earlier loss with a heavier investment. This is a common price averaging strategy but it will not work well for the purposes of compounding. For compounding, you should rely on the pips you can take over time, as opposed to waiting and putting more investment in per points to compensate for losses.

How Does Compounding Work?

Compounding is a method that works best for trading strategies that can take positive pips over time, regardless of the position size that you are putting on the trade. For example, if all of your trades were a 1 standard lot over time, you would eventually be profitable over the trading period. If you need to change the position to compensate for other losses, it means you might be monetarily profitable but you won’t be profitable when it comes to measuring total pips gain. However, there’s a workaround which we’ll get into that later once we understand how to net total pips.

Netting Positive Pips

Having positive net pips is the key to compounding. The next requirement to make the system work is that your trade success rate has to be above 51%. You need to be successful from your entry to exit rate at more than half the time. If you hit this rate, you can use the leverage that is provided in the forex market to work for you. But like all trading methods, you have to do it intelligently and methodically, and not in a way that will put your hard labor at unnecessary risk.

When you have the two key basics (net positive pips and an accuracy rate at or above 51%) then you should focus on tweaking one thing. Shift your workflow to manage your actions by percentages. There are two ways to go about measuring percentages by the portfolio total value according to each of the two ending points. One is from the profit expectation and the other from the risk perspective. You only need to choose one to calculate from.

Sharp Steep Gain Curve When You Profit

Compounding Positive

For example, let’s say you’re going to risk 0.5% from the account value for each trade which is a percentage weighted on your risk side. You can also define that you wish to profit 1.5% for every trade that you’re making. This is working out your strategy from the other end of the profit. Of course, you should be trading by your market analysis strategy which will determine the price levels you will put at your entry, your maximum risk, and your targets. Once you have this and the percentage, you can re-calculate how much each position should be. In this way, you’ll earn a fixed percentage for each win, rather than taking pips on a fixed position size. This way you have ROI on each trade to invest in subsequent trades. You may read more about Risk Management Here.

Shallow Descending Curve When you loss

Compounding Negative

Another benefit of working in percentages is also defensive. Every time you lose a trade, your account will degrade by a certain percentage and if you’re unlucky and experiencing a string of failures, each and every trade that you take prior to a loss should be weighted less and should have a lower position size that is risked. The result is your growth curve will look exponential, while your losing curve will be a shallow descending rate of loss. If you look all the way to your zero dollar amount, you’ll realize that you’ll never hit it because losing the same percent over and over on degrading balance, will go on infinitely.

If you have over 51% accuracy rate and that rate is totaling a net pips and you start sizing your position by percentage from your current balance, this means you’ll be relying on prior winners which will net you an exponential growth rate. If you have a higher success rate, you can be even more aggressive with your compounding.

Compounding Swing Position

It’s important to be aware that compounding doesn’t necessarily need to be from trade to trade. Compounding can also be managed through a running long term trade where you hold positions and you know when your trade has gone to key price levels that are confirmed to not return. Instead of rising your stop loss, you can dedicate part of the floating profits you’ve made to scale up your position once price has completed a retracement and confirmed that it’s going for the next possible wave. You can compound what you’ve gained on your non-realized position to scale up and gain more on the trade.

How to work around a less than 51% success rate

This is a bit trickier and you need to be more mathematical and analytical towards how you do this process but it’s still possible to compound even if you don’t hit the 51% threshold. Instead of considering each trade as a success, you should measure your sequence success rate. If you take a sequence of trades and bring them into a profit, once you create a profitable sequence in gaining net pips, this will be considered as if it was one position. Combine such sequences to reach the ROI goal. Instead of one trade, zoom out and consider multiple trades as part of a sequence until you make it profitable.

However, when you work in a sequence and change the position size, you should know how much you’ll allow yourself to risk in one sequence. This means it’s integral to have a way to define what is a losing sequence. From the defensive perspective, you can go endlessly without admitting you’re on a losing streak. Therefore have a strict definition for what is a losing sequence. Only once you have this firm guideline can you go on to define what is a winning sequence. Never use this strategy if you can’t enforce this definition on yourself.

To sum up, compounding is a money management technique that lets you take money you had made in profit and invest it in more weight. Over time, you will build up your trading account capital in an exponential and highly profitable way. It takes time and skill to master the technique but once you do so, a windfall could be at your door.

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