I’m sure you probably have heard that compounding can help grow your account geometrically. But the normal way of compounding can take some time to grow your account. My method of using compounding takes it to the extreme to grow your account much faster without increasing your risk greatly.

Here, I would like to share a strategy which, if used properly, can help you grow your account pretty quickly. It introduces compounding into your money management strategy. 

First, let me show you the power of compounding through the normal way by a hypothetical example below:
If you have $10,000 invested and it gives you a rate of return 20% every year, you will have $380,000 at the end of 20 years by re-investing the profits (i.e. compounding),while you will only have $50,000 at the end of 20 years without compounding. You can see that compounding increase our total account by more than 6 times. 

Okay, let me move on to talk about using compounding in Forex Trading. 

But, first let me digress a bit. For those who are not familiar with R-multiple concept, let me explain a bit on that. It was introduced by Dr Van Tharp. 'R' is simply the dollar risk per trade. It’s nothing but a reward-to-risk ratio. Let say you risk $100 dollar per trade to make $500. Your risk to reward ratio is 1 :5. Your risk is 1R and your reward is 5R. Another example, you are risking $1000 dollar per trade to make $500. Your risk reward ratio is 2:1. Your risk is 1R and your reward in this case is 0.5R. We always take our risk as 1R and calculate your reward in terms of R-multiple. 

Let's get back to compounding. Let say our 1R is set to be $10( meaning we risk $10 per trade). We increase our dollar risk per trade(the dollar value of 1R) by our previous winning after each winning trade. Please take note that we are NOT compounding after each and every trade. We only compound after we had a winning trade with the expectation that we will have a winning streak( based on our testing data). If you hit a losing streak, your risk would be the same amount regardless whether you are using compounding or not.

So, let us see the results for 4 consecutive winning trades:

For a risk reward ratio of 1:2:
$10 --> $30 --> $90 --> $270 --> $810
(For our first winning trade, we risk $10 per trade,and with a risk reward ratio of 1:2, we make $20 in profit and have a total of $30 now. We then can risk $30 for our second winning trade, we make $60 in profit and have a total of $90 now. The same goes for the third and the fourth winning trade. At the end of fourth winning trade, we will have $810 in total which is a whopping 8100% return over our initial risk.)

For a risk reward ratio of 1:3:
$10 --> $40 --> $160 --> $640 --> $2,560
(At the end of fourth winning trade, we will have $810 in total which is a whopping 25600% return over our initial risk.)

For a risk reward ratio of 1:4:
$10 --> $50 --> $250 --> $1250 --> $6,250
(At the end of fourth winning trade, we will have $810 in total which is a whopping 62500% return over our initial risk.)

For a risk reward ratio of 1
$10 --> $60 --> $360 --> $2,160 --> $12,960
(At the end of fourth winning trade, we will have $810 in total which is a whopping 129600% return over our initial risk.)

We will take a look at another scenario where we risk $50 per trade:

For a risk reward ratio of 1:2:
$50 --> $150 --> $450 --> $1,350 --> $4,050

For a risk reward ratio of 1:3:
$50 --> $200 --> $800 --> $3,200 --> $12,800

For a risk reward ratio of 1:4:
$50 --> $250 --> $1,250 --> $6,250 --> $31,250

For a risk reward ratio of 1
$50 --> $300 --> $1,800 --> $10,800 --> $64,800

As you can see the huge potential comes with incorporating compounding into your money management strategy. You are simply 'reinvesting' your previous profits into your next trade and expotentially increase your profits for the next trade when you are on a winning streak. The higher the risk reward ratio and the higher the initial dollar risk per trade, the greater effect compounding has on your overall profits of a winning streak.

What kind of trading strategies can compounding strategy be useful for?

it is suitable for trading strategies that are:

(1) have a risk reward ratio higher than 1:1
(2) frequency of having winning streak of 2 and above is considerably high

Take Note: Compounding Strategy is not used to turn a losing trading system into a profitable trading system. It is used to increase your profits and grow your account faster for a profitable trading system. 

Let me illustrate by a few hypothetical examples:
Example 1: Trading Strategy A with a Risk Reward Ratio of 1:4 and Win ratio of 35%. It frequently has 3 winning trades in a row. Our starting trading capital is $1000. Our risk per trade(1R) is $20.

Sample Trading Data : 

How To Grow Your Account Fast Without Increasing Your Risk-example-1-png

Example 2: This is just a hypothetical scenario where winning trades and losing trades alternate. Our starting trading capital is $1000. Our risk per trade(1R) is $20.

Sample Trading Data : 

How To Grow Your Account Fast Without Increasing Your Risk-example-2-png


With a compounding strategy, an originally winning trading system turned into a losing trading system because it doesn't fulfill one of the two important prerequisite which is high occurrence of consecutive winning trades. 

Win Rate Needed To Be Profitable Based On Risk Reward Ratio

How To Grow Your Account Fast Without Increasing Your Risk-win-rate-based-risk-reward-ratio-png

As you can see, the higher the initial risk reward ratio brings you a much higher overall r-multiple win with more consecutive winning streaks. For example, if you risked 1:5 and aim to get one set of 3 consecutive win streak, all you need is just 1 winning set in 216 trades to be profitable (roughly a win rate of 0.005%).

Try out in your own trading and let me know how it goes!