Effect of Compounding

So how does compounding affect your short-term trading? As a practical example, we have listed an example of the CFD (Contract for Difference) trade suggestions from the 20th October 2005 through to the 16th November 2005. The table below lists the result of the respective suggestions.

Note: The leverage for all suggestions below is based on a twenty-times leverage, though individual CFD Providers may provide differing leverages for each stock.

Static Capital Outlay Vs Compounded Outlay:

Assumptions:

• Two individual traders with a theoretical trading bank of $10,000 each.
• No brokerage or interest component considered.

Static Outlay Model

Trader one outlays $1,000 per trade constantly. The spreadsheet below indicates the growth of Trader One's trading bank based upon the above trade suggestion outcomes.

Compounding Outlay Model

Trader two chooses to outlay 10% of their running trading capital per CFD trade suggestion. This is a constant ten percent of the trading bank outlaid per trade. The spreadsheet below details the growth of the compounding outlay.

Owing to the positive nature of the underlying CFD trade suggestions, the effect of compounding on this instance enhanced the overall return. On the contrary, had the underlying suggestions been of an aggregate negative nature, the compounding effect would dilute the return. In the above case, the compounding effect resulted in a 11.9% greater return ($1,190.16).

IMPORTANT Note:

The purpose of the example above is to only HIGHLIGHT the difference between one strategy compared to another rather than advice on how to manage your trading bank. As can be seen from the above, the extra leverage of compounding can be a double edged sword, either swelling or diminishing one's trading bank.