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How Compound Interest Can Work for Traders

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If you have been trading stocks, forex or other financial instruments for some time and you are not yet using the power of compound interest, you are losing a lot. Compound interest is interest earned on accumulated capital and previously earned interest put together.

Compound interest was described by Einstein as the 8th wonder of the world. Compound interest is what has enabled some people to turn small amounts of money into thousands and even millions of dollars. Believe it or not, compound interest has also made banks and credit card companies rich, even as it makes those on the wrong side of the coin broke and in debt.

Compound interest is therefore a double edged sword, but you can put it to work for your money today. There are many retail traders who are complaining of losing money trading. A careful review of their trading activity will show that they do not understand the power of compound interest, and so they use maximum risk in a bid to achieve maximum returns. With compound interest, you can use minimum risk and attain maximum returns. The difference between the start and end points is time, consistency and discipline.

So how can you use compound interest as a small time trader with just $1,000 as trading capital? Look at this Excel sheet.

compound interest

The formula has been calculated to show what a trader that starts a trading career with $1,000 can achieve in three years of trading with compound interest. This Excel sheet assumes a 20% compound interest increase every month.

$1,000 is money that every one of us can get if we cut back on a few bottles of beer over a few months, pick up a side gig or moonlight a little. Once you have your $1,000, open a trading account. It does not matter if you open an account on Trade-24 or a stock trading account. You can even move the money around. Put it in stocks for a few months, then in forex or other CFD accounts, and keep trading it. The focus is to try to make 20% a month using minimum risk. How can this be achieved in practical terms?

  • Let’s take the first month. The aim is to make $200 on a $1,000 account size. Trading 20 days in a month, all the trader needs to make is $10 a day on that month. It is possible to make $10 using 0.01 lots on a $1,000 account. Trade 24 and many other brokers offer micro lots trading. This is a demonstration of how to use very low risk to attain targets. $10 a day may not seem like much, but as you can see from the Excel sheet, compound interest can push up the account to a point where the trader can be making $500 a day while still using a similar risk profile as the $10 trades.
  • As the account grows, the trader can increase the lot size of the trades to match the increasing account without increasing the level of risk involved. For instance, if the trader uses 0.01 lots for trades when the account was $1,000, the lot size can be doubled by the 4th month when the starting account size is $2,073. Forex lot size calculators can be of great help here.
  • The trader can adjust the figures on the left side of the Excel sheet. Account capital used in starting the journey can be increased or reduced, and the % returns target adjusted from 20%. The trader therefore should get someone proficient in Excel to compile the formula. For instance, D5 = SUM (A5*B5)+A5 and E5 = SUM (D5-A5). The formula for other cells can be compiled from these base formulae.

Conclusion

Many traders may see this and decide that it looks good and is worth the trial. But then they never get around to the practical side of it. You need to start now to be able to set yourself on this path. Is three years a long time? It is not. You can start now and check to see where you will be when the next FIFA World Cup in Russia kicks off in just under three years.

 

About Kim Parr

Kim Parr is a private practice optometrist, freelance writer, and personal financial blogger. You can follow her journey to 20/20 financial vision at Eyes on the Dollar.

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