I made a little spreadsheet about the way compounding (both winning and losing trades) affects our final balance. I think this topic is very important to traders, especially if they start with a low investment, and it should be understood by every trader, including myself.
Now, before getting to it, I started assuming that, by componding your losses, you never lose your account. At least, not that quickly. Because of this, I considered a fixed 20% risk per trade, updated for every single trade. I considered spread and taxes included in the risked amount.
I will attach 3 pictures, each calculated after 50, 100 and 200 trades respectively.
Now, in dark green, I showed some âeasyâ (although far from me) possible results, with decent win ratio and risk:reward. In the 50 trades image, you can see that you can double your balance after 50 trades either with 50% win ratio and 1:1.2 R:R, or with 54% win ratio and 1:1 R:R.
Being consistent with either performance, when you reach 200 trades, the results are unreal, almost impossible. Itâs not even worth mentioning the results with better performances than those. ( like 60% win ratio and 1:1.2 R:R and after 50 trades you increase your account sixteen times)
I hope Iâm not missing anything and that my calculations are correct. I am not here saying I found the Holy Grail, I just want to understand, as Iâm sure everyone does, if I see this correctly. However, if we reach the conclusion that this is right, I would also implement compounding after each trade into my trading plan.
Iâm sorry, it seems I was misunderstood, or maybe I donât understand what you are saying.
I would like to add some clarification.
My post wasnât at all about forex robots or gambling. I was just trying to say that if you had, and that is a big if, a strategy that over a certain period of time gave you those results (like 50% win rate and average R:R of 1:1.2) and if what I calculated above was correct, then the best thing you could have done was compound after every trade.
Or, in other words, it seems better to adjust your trading sizes after every trade, and not once a month or once a week.
Of course we are not robots, of course everything can happen, but I was talking about having a strategy, using that strategy and getting those results on average, and then, after analyzing your results, what would you say is the best way?
Iâm here only to understand compounding and see if I can integrate it in my strategy.
Later edit: I found it. It was a calculation error. It was to good to be true, wasnât it? Screenshots coming later
It does look more plausible than the last ones. It needs more trades to double the initial balance (60 trades) , and the growth is not so exponential, itâs more realistic. On the bright side, the risk is lower.
I feel I give the wrong idea about myself, Iâm not mesmerized by easy money with this, but simply trying to calculate, objectively, the best and fastest way to grow my equity. Of course, by assuming I already have a WINNING strategy, which I donât.
However, doubling my equity after 60 trades with a 54% win ratio and 1:1,2 risk:reward does look âeasyâ. Now there is the matter of risking 12% per trade, and there is more to talk here, but Iâm sure there can be found a way to manage that.
Playing around with numbers in my spreadsheet, I found that for some strategy statistics (win ratio and average risk:reward) there is an optimum risk. Itâs not always the bigger the risk the higher the reward, or, to put it differently, increasing the risk past a certain level slows down your growth. I will return later with more information.
Let me explain why i think compounding doesnât work. In my 5 years experience of trading. Sticking strictly to the plan just seem such an inefficient way to gain the profit. It is way darn too slow. Personally, i really canât take it. Perhaps what i really canât tolerate is this. Each time i get a trade wrong. It really hurt me. It is immensely painful for me.
Thus, i aim to hit my target every time i enter a trade. I get so worked up when people say win loss ratio doesnât matter. If it is not important, then what is our edge?
Iâm a firm believer of Trade what you see. For example, i have a position at the start of asian session. Say iâm slightly positive or negative but my target and stop loss is not triggered yet. When it is close to the next European session or any high impact news. Base on price action of the chart, news i stumbled upon plus my preconveived idea of what i think price should be headed, i noticed weird price action at my current chart and the news just get increasingly unsupportive. I will close my trade and either choose to monitor the market or enter my trade in the opposite direction.
On top of all of the above, i have to monitor how i am feeling. Do i feel sick? Will i be able to look at the chart later on at the next high impact news hour or next session. I question if i would be available for the next session to see the chart.
In trading, constant monitoring is neccessary. There is no easy way out. Fixed Automated Expert advisers doesnât work or it is simply not efficient at all. It is not an accurate way enough to trade forex.
Our mental clarity is not always at its optimum state. When i feel sick. I just close my trade and rest. The market is super fickle minded. I have a day job, wife , children and friend to attend to. Iâm not always available for the market. You have no idea how challenging trading forex is.
Talking about compounding gives people an inaccurate picture that trading forex is an easy way to make money.
Compounding is possible, and used by many traders, if not all at some point in time. When your account hits a new watermark level itâs totally acceptable to compound up.
The points above are rather misleading and very much off topic.
This i agree. But showing a chart like that gives people an impression that making money from forex is easy. I donât like that. The Op is saying we should compound after every trade. I think that idea is wrong.
Some trades are golden. Regardless whether we have hit a new watermark or not. We have to bet big and be prepared to lose a huge amount. Its like holdem. You have pocket Aces, preflop someone re-reraises you. Donât you have to go All in?
No, we really donât have to do this, and successful trades do not do that, at all. You said youâve been in the FX markets for five years in a previous post - I really really question this on a profitable level.
A proficient retail trader will understand his risk and reward parameters prior to entering a trade, as well as the probabilities and average trade expectations. There will be no change to the trade once it has been placed, regardless of the market - comparing this to poker is nonsense as there is no common resemblance.
@alphahavoc have a little think about what you are saying - itâs rather distracting and misleading for newbies who are here to learn?
Okay, i understand what you mean. Iâm quite off from the topic in question, ainât i. Thatâs why i flunk my General paper twice 20 years ago LOL. Anyway, i still think we should hit the market hard when opportunity arises. I rest my case here.
Yes, compound after every trade. But keep your max risk per trade at a set max %age. Many people use 2% but thatâs not a law: the point is that X% of your account lost is still only X% of your account lost. Compounding does not increase your risk but does increase your opportunity when you convert % gains into capital - so a gain of 25% of an account worth ÂŁ2,000 is ÂŁ500, but 25% of an account worth ÂŁ20,000 is ÂŁ5,000.
Thatâs exactly why trading is not anything like holdem at all. With trading, you donât have to do that, and you shouldnât. Not if youâre in it for the long term.
On the contrary, all long-term successful traders, from very small-size retail traders to big hedge funds, are using elements of compounding in their approach to money-management.
Compounding is an intrinsic part of position-sizing.
Not in the way the original poster described it, of course - thatâs madness.
But much of what youâre posting here is actually equally erroneous.
I do not think that is crazy. I do it most times. If you think the probability of getting a particular trade right is high. Why shouldnât we utilise more margin?
Iâm just using holdem as an analogy. If you are unable to appreciate the resemblance. What more can i say?
I would agree that if we hit a new level of watermark level in our capital amount. We should compound a bit. But compounding every trade just doesnât seem right to me. You compound for every winning and losing trade or just winning trades? Do you compound for losing trades as well? Say you only compound winning trades. During the period of time when you have more losing trades than winning ones. How do you deal with that?
Obviously position-size depends on expectancy. Nobodyâs suggesting otherwise.
Thereâs no system or method which a retail trader can sensibly use for which anything like 20% position-sizing could conceivably be appropriate. This is crazy talk.
Youâre confusing âmarginâ with âposition-sizeâ.
On the contrary, compounding after every trade is the logical, mathematically sensible way to do it.
If position-sizing is proportional to expectancy (which it is) then âlevel stakesâ, with forex trading, means risking the same proportion of the account on each trade of the same expectancy.
If you donât compound after each trade, youâre doing it arbitrarily, not mathematically.
One of the very few advantages that retail traders have over the professionals is position-sizing granularity.
Thereâs no point in not using it.
For every trade, naturally.
Otherwise youâd effectively be varying the stakes according to the previous result(s).
No logic at all in that?
You can say that, if you want, but I donât.
If you compound only after winning trades, then it means that during a losing run, youâre effectively increasing the position-size (as a percentage of the account, i.e. âin real termsâ). That would effectively be a watered-down Martingale approach.
Itâs only a small sample because the actual calculations this time were not made in excel, so I had to copy those results manually.
I noticed that for a strong edge ( above 60% win ratio and above 1:1,6 R:R) the more you risk the higher your gains. However, for a thin edge, with a win rate close to 50% and risk:reward close to 1:1, there is an optimum risk.
In the picture above, in the green cells, you can find the risk per trade, in %, that gave the biggest return for those statistics (from the 1%-30% risk per trade interval).
Again, I hope my math is right. As you can see, for a strategy that gives a 52% win ratio and an average risk:reward of 1:1, the highest returns are gained by using a 4% risk per trade compounded after every trade. With a 5,6, or 7% risk per trade (of course, compounded after every trade) the gains are lower. I will use this information in my trading plan.
To the contrary, and as discussed in a previous post, compounding down is not such a good idea as itâs stacking the odds even further against you? If you do compound down then youâre going to have to âwinâ more trades than you lost to make back your initial loss amount (when keeping other variables constant)- illogical and not an effective approach?
Maybe thereâs a misunderstanding. Is it possible you and the rest of us have different ideas of what âcompoundingâ means.
To me it means adding the gain or loss from each trade to the account value, so that although the percentage of account risked per trade, the actual amount risked in money terms is constantly being adjusted.
Do you think compounding means this? Or do you think compounding means adding to a live trade? (though I would call that pyramiding if its in the money and doubling down or averaging down if its a loser)
Thatâs right, but itâs better than the alternative, which is to increase your position-size during a losing run (and thatâs what happens, in real terms, if you donât âcompound downâ as youâve put it).
Itâs so simple: either youâre risking level stakes, with every risk being proportional to its expectancy (which means you compound after every trade, up or down), or youâre not.
If you are, then you need to do so in both directions.
[quote=âtommor, post:18, topic:112147â]Or do you think compounding means adding to a live trade?
[/quote]
Adding to winning trades is âscaling inâ, really, not âcompoundingâ. Thatâs not what Iâm talking about, anyway, and I donât think others are either.
If you donât risk an equal proportion of your account on trades of equal expectancy, then youâre varying your risk according to previous results.
If you donât âcompound downâ, as RISKonFX has called it, youâre using a watered-down Martingale during a losing run in that youâre increasing the proportion of your account at risk with every successive trade.
It would make more sense, certainly, if he turned out to have been talking about something different from the rest of us.
I understand RISKonFXâs view about the downside of what he calls âcompounding downâ being a prolonged recovery. Thatâs so. But better than increasing risk during a losing run.
Itâs very easy to take your eye off the ball, with these things, and become attached to the academic argument and the mathematical process, and forget WHY it matters so much, and what the practical point is.
The practical point is that during a really bad run, you need to have away of deciding whether youâre being unlucky or your system no longer works.
This is why âlevel stakesâ are much better (even though they involve âcompounding downâ, which prolongs recovery). You get longer when you most need it, when things are going wrong.
Increasing your risk while youâre losing is a terrible idea.
