Pros and Cons of Compounding

Winsor Hoang |

Compunding, forex trader, investment strategy, forex market

Let's be real. The goal of trading is to earn money. Traders risk their hard earned dollars in hopes of turning them into larger, hard earned dollars. Compounding is largely considered as a viable method of making this happen. The process involves taking the earnings on previous investments and reinvesting them back into the market to, hopefully, make more earnings. Continuously repeating the process theoretically results in higher profit margins. Though compounding is a respected investment strategy, the savvy Forex trader understands both the pros and cons of the process.

The Good

There are two major advantages to compounding in the Forex market. The first is that compoundingrewards the patient trader. Given a choice between short term earnings and a substantially larger, long term earnings, the most successful trader is going to choose the long term option.

Compounding is largely promoted as the surefire method of creating these long term earnings. For a responsible trader, who carefully navigates the exchange markets, compounding can truly lead to riches over an extended period of time. The second advantage is the potential for substantial growth from a small initial investment. In theory, compounding allows mini and nano account holders to eventually experience large earnings on their future reinvestments.

The Bad

Though compounding is a legitimate trading technique, it can create a false sense of security for the trader, which may result in major earnings losses and disappointments. This trap is based in the false belief that it is possible to make a specific amount of pips per day in the Forex market. Doing so would require a substantial success rate among all completed trades.

Not only is this expectation highly unlikely, but it also does not take into consideration the fact that wrong decisions result in losses. For each loss, the trader needs additional winning trades just to break even. The compounding trap also requires the incredibly good fortune of capturing the correct market movements consistently, on a daily bases. Successful traders must understand that this perfect storm is incredibly rare.

The Ugly

If compounding was truly as fool proof as its reputation suggests, then every Forex trader would be a millionaire, and numerous times over. Not only is this not the case in the real world, but the majority of new traders quickly abandon their trading aspirations.

The numerous variables of Forex trading create an environment where substantial compounding success is the exception and not the rule. The promise of quick, guaranteed earnings is a false one that some Forex instructors use to lure new traders into their trainings courses. New traders enter a world where the odds of success are stacked against them. Knowing the pros and cons beforehand arms you with tools to avoid Forex training scams.

Learn more about Winsor's trading philosophy from my book: The Bull, The Bear, The Baboon – FX Lessons Learned the Hard Way

 

 

 

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

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