Many people see forex as a way of getting rich fast. One of the ways they hope to get rich fast is by compounding their winnings. This means they will place a trade, win, and then increase the size of their next bet, using the winnings from the previous bet.
This can seem like a great way to make loads of money. After all if your strategy allows you to win an average of £10 with every £100 bet, you should be able to win £20 with each £200 bet. Right?
Let’s go with this assumption for now and have a look at what happens if you compound your winnings.
First of all what is a reasonable amount of money to start with? Let say 1000 units of your currency. This could be 1000 Pounds, 1000 Dollars, 1000 Euros, it doesn’t matter the result is the same.
If you have £1000 to start with then let’s say you are able to increase your capital by 1% per day. That would mean turning £1000 into £1010 on the first day. How hard could that be? You have a whole day and you only have to make £10. On the next day we’d place bets using our £1010 and we should be able to turn it into £1020.40.
It doesn’t sound difficult does it? Of course some days may be better than others but for the purposes of our experiment we are assuming an average of 1% per day increase in capital.
Compounding your way to a million
How long would it take to make £1,000,000 (one million) using 1% compounding?
After day 232 you would already have made £100,000 (one hundred thousand), and by day 695 you would have your million. Here’s a graph to show the effect of compounding up to one million.
Maybe you think 1% is too much or too little for your strategy. Here’s another graph which shows compounding with 0.5%, 1% and 2%.
With a strategy that compounds your winnings by 2% each day you will be a millionaire in 232 days. That is achievable in less than a year, just working 5 days per week!
At 0.5% you will have to wait 1386 days to make your first million, but if you average the million over the 1386 days that works out at 721 Pounds/Euros/Dollars per day. Not bad going!
Can I become a billionaire with compounding?
So far I’ve just looked at compounding up to a million. But what if we kept on compounding for longer? How long would it take to make 10 million, 100 million, a billion, or even more? Here’s a graph that uses 1% compounding for a much longer period of time.
Remember at 1% it takes 695 days to make a million. Getting to 10 million will only take you another 231 days (926 in total).
You will have made 100 million by day 1158, and by day 1389 you will be a billionaire! If we assume you work 6 days per week (you can’t really do 7 days a week with forex) you will be a billionaire in 4 and a half years!
Let’s not stop there. At day 1620 you will have 10 billion, and by day 1782 you will have 50 billion. Whether you are betting in Euros, Dollars or Pounds you should now be the richest person in the world by this point.
It all sounds so easy.
Back to reality
It can be fun to think about compounding winnings in this way, but now it is time to go back to reality.
It is just not possible to keep compounding like this. You can probably do it for a few weeks but then you will run into trouble.
If it was this easy don’t you think the rich lists of the world would be full of forex traders who are compounding their winnings in this way? As the rich lists aren’t full of these people there must be something that prevents it from being this simple.
As the stakes get higher you will suffer more from emotions as you realise you are playing for much bigger stakes. You are likely to make mistakes, or modify your strategy in a way that makes you less likely to win.
Even if stay as cool as a Vulcan you will run into other problems. When the bets reach a certain level your broker will begin to notice. They may start referring you to the dealer rather than taking your bets direct. This can cause you difficulty with making or closing your bets at the price you want. This will reduce your profit, and maybe turn your winning trades into losers.
If your bets get even larger (and assuming your broker can handle it) you will get the attention of the markets. Your bets will begin to influence the forex market, meaning your strategy will further break down.
When your trade sizes are larger than normal trading volumes the spread will widen as you won’t be able to easily find buyers or sellers for your whole trade size. The spread has to widen in order for you to get enough buyers or sellers to take your huge trades.
This widening spread will again affect your strategy and in all likelihood will turn a winning strategy into a losing one.
As the stakes get higher your chance of making a fatal mistake increase. You only need one big mistake to take your account back down to zero. If you are hoping to win day after day for hundreds of days you are almost certain to be disappointed.
It is good to know about the effect of compounding, but don’t get carried away. You can’t keep compounding your winnings forever.