When people trade Forex they often forget about the power of
compounding. Some brokers even inadvertently make it difficult to get the
benefit of this very powerful force, by insisting that all trade sizes have to
be in ‘lots’ or ‘micro lots’. This means that position sizes can only be
incremented in large amounts, so that compounding can only be done on long time
scales, such as every month or so, if it can be done at all.

The compound interest formula is one of the simplest there
is. To make it work, it is only necessary to know the starting amount (which we
designate to be ‘P’, which stands for Principal), the number of compounding
periods, which we call ‘t’, for time, and the interest rate to be applied on
each occasion the amount is compounded. This means, for example, that if we
compounded each week for a year, we would have 52 compounding periods, but if
we compounded each month the number of periods would be 12. The interest rate
in the first instance would be the profit rate achievable per week, and in the
second case it would be rate we could reach every month.

Here is the formula (‘A’ is the amount we will arrive at
when the compounding is complete):

In plain English: Amount equals principal, multiplied by one
plus the rate, to the power of the number of compounding periods.

The more often compounding can be carried out,
the more the effect will be seen. That is not all. Compounding also has a
beneficial effect on the downside. On those occasions when a drawdown takes
place in the account (and they will occur), our software reduces the amount of
the position size using the same principle as when compounding on the upside.
This has the effect of reducing the amount of drawdown during those periods
when it happens.

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