Whether you're dealing in cash, stocks, currencies, or commodities, compounding is one of the essential principles for any trader or investor to understand. Its precise application may vary somewhat according to the instrument you're trading, but the essence of compounding is always the reinvestment of earnings and profits. And it's the consistent reinvestment over time that creates the explosive growth that can turn even small account traders into very wealthy individuals.

How to Grow Your Profits with No Extra Risk

For forex traders, reinvestment means retaining profits in their trading account and adjusting position sizes accordingly. In this way, the dollar amount staked on each trade can be increased without any change in the percentage risk to the account. And the potential profit on each trade naturally rises in proportion.

For example, a trader who wants to risk no more than 2% of a $5,000 account will need to place a stop loss at no more than $100. A suitable profit target might then be $200, $300, or more, depending on the strategy.

Taking a 5% monthly profit as an example, and making no change in position size, that trader would then have just an extra $250 a month to trade.But apply that sum to the trading account and their $5250 allows them to set stop losses at $105 and profit targets at, say, $210 or $315. Make another 5% profit on that $5,250 and they will then have an extra $262.50 to add the next month.

The Magical Power of Compounding

It might not sound very dramatic in these early stages, but the magic of compounding is how growth accelerates over time. And you can get an idea of how this might look in practice by trying my free Forex Compound Calculator right here. You should pay particular attention to the graph it generates, which provides a vivid picture of exponential growth.

How the Calculator Works

Just enter your starting trading account balance, your projected monthly profit, and the relevant number of months to see where you might be in a year, two years, or at any point in the future. Now, of course, in the real world, it isn't quite as simple as that. Most traders will want to spend some of their profits at some point, rather than compounding everything they earn.

One popular strategy, for example, is for traders to bank half their monthly profits and reinvest the rest, but this is very much a matter of personal preference and will likely change over time for each individual. So for now, just run some projected figures through the Forex Compound Calculator.