Compounding is very important in trading and investing because it is a way that potentially gives an opportunity for your trading account to grow very large in the long term. All compounding means is to simply leave your money in your account and let it grow. Whilst the account grows, assuming the same returns each month (this won’t ever happen in principle) it will grow by a bigger monetary value each time. Let’s say your trading account starting balance is $1000 and you earned 2% per month for 24 months. If you withdrew this 2% each month for 2 years you would still have $1000 in your trading account and you will have withdrew $480. However, If you had left the money in the trading account and compounded it, your account would be worth $1607.82. Considerably more. As you can see you would have extra money by compounded. However, in the short to medium term, compounding doesn’t make a huge difference. It is in the long term where it really fires into action. The chart below shows the amount you would earn if you withdrew your 2% every month (simple interest) and the amount your account be worth if you compounded your account.
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As you see, after 10 years of compounding the 2% per month grows substantially more more when it is compounded. If you had left the $1000 in your trading account at the end of year 10, it would have gone up by over 10 times. If you had withdrawn it each month, you would only have gone up by just over 3 times. A big difference. This really outlines the power of compounding. As we know returns are not fixed with forex trading but this does outline the theory.
