Ah, compounding, the mystical force that exponentially grows your earnings. When we say exponential, it means your returns on initial investment keeps growing. It’s like when you plant a fruit tree, and from one seed, you have an entire tree. That’s the logic of a forex compounding plan.
We won’t spill all the beans here; let’s keep moving and discover the power of using a forex compounding plan.
- What is a Forex Compounding Plan, and How Does Compounding Work in Trading?
- How to Use a Forex Compounding Calculator?
- How to Use Compounding in Forex Trading – Forex Compounding Strategies
- Forex Compounding Strategy – Pros and Cons
- Download Our Forex Compounding Plan Google Sheet
- BONUS: Forex Compounding Plan PDF (Download)
- In Summary – How Compounding Can Help You Grow Your Trading Account Faster?
What is a Forex Compounding Plan, and How Does Compounding Work in Trading?
Forex compounding is a trading strategy that involves reinvesting the profits earned from profitable trades back into the market. The idea is to use the profits to generate even more over time, creating a cycle of growth that can lead to significant returns.
For example, suppose you have an initial balance of $1000 in your Forex account. Each month you make a 5% profit from a fixed interest rate or by an average daily pips target. In the first month, your balance would be $1050; in the 12th month, your balance would be $ 1795.86.
So, you see how this magical economic force works. No wonder Albert Einstein called it the 8th wonder of the world. He said, “Compound interest is the eighth wonder of the world. He who understands it earns it; he who doesn’t pays it.”
Here’s how the forex compounding plan works:
- You start with a small/medium trading account size.
- As you make successful trades, your trading account will grow.
- Instead of withdrawing the profits, you reinvest them back into the market.
- Your trading account will grow exponentially as you continue to make successful trades and reinvest profits.
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How to Use a Forex Compounding Calculator?
The most important aspect of forex compounding is to calculate your returns. If you wish to do that without a calculator, it can be tiring and requires a lot of effort to calculate the returns. However, if you want to try it, here’s the forex compounding interest formula.
FV = P (1 + r/n)(nt)
Fortunately, we have a Forex compound calculator that can help you.
To use it, here’s what you need to do:
- First, you have to enter your starting balance. We inserted $10,000 for this example.
- Then there are years and months (though you can also use the compounding calculator for days or any other time frame). Here you can enter the compounding period.
- Next, we have the percentage. It is where you put your returns (fixed interest rate, or pips daily target). We inserted 5% as an example.
- After that, you have to choose your compounding period, hence, choose monthly or yearly.
- Finally, you have to select your account currency.
Hit the calculate profit button, and you have a forex compounding projection and a complete list.
How to Use Compounding in Forex Trading (Top 3 Forex Compounding Strategies)
Forex compounding sounds great, but you need a strategy to reap the compounding tree’s fruits in your investment portfolio. Some of these forex compounding strategies are suitable for scalping or day trading, while others work best for swing and position trading.
To help you get started, here are some of the best forex compounding trading strategies you can apply in the foreign exchange market.
1. 10/20 Pips a Day Compounding Forex Strategy
First, before you start utilizing this strategy, you must decide which currency pair you will trade. You also need to define your lot size, risk-reward ratio, and time frame (the compounding period).
So, as the name implies, the 10/20 pips-a-day forex compounding strategy is essentially a strategy in which a trader aims to capture 10 or 20 pips a day and increase the account balance by reinvesting each day’s profit on the following day.
The reason why this strategy works is that you are not aiming to find long market trends. Instead, the purpose is to collect the same amount of pips daily and reinvest your profits.
At basic, you can use any trading technique to capture 10 or 20 pips daily. It does not matter how you achieve this goal as long as you make 10 or 20 pips a day. The most important rule is to set a risk-reward ratio that will work in your favor, and the time frame (1H, day, week, month).
Let’s see and example of how it works with the 10 pips a day forex compounding plan.
- Account balance – $1000
- Risk Per Trade – 1%
- Time frame – Daily
- Risk-reward ratio – 1:2
- Lot size – 0.1
Now, assuming you’ve made a profit of 20 pips, meaning $20 on the first day, your account balance will be $1020. You use the same settings the following day; however, this time your risk per trade stands at $10.2 instead of $10.
The lot size for the second day should be 0.102. If you make another profitable day, you’ll increase your account balance by $20.4, meaning you’ll have $1040.4. Then, guess what, you do the same thing the following day. And that is how the 10 pips a day forex compounding strategy works. Instead of withdrawing profits, you reinvest and use them in the following period.
“Compound interest is the eighth wonder of the world. He who understands it earns it; he who doesn’t pays it.”Albert Einstein
2. Compound Interest Trading Strategy
If you want to skip the hustle of a 10-20 pips strategy, you can look for an interest rate differential strategy. An IRD (interest rate differential) is a difference in interest rates between two nations’ currencies. Forex trading is also known as a carry trade strategy.
A carry trade transaction involves buying a high-interest currency and selling a low-interest currency. For instance, at the time of writing, USD is a high-interest currency, while JPY is a low-interest currency. Therefore, your profit is the interest rate differential. You will gain a fixed interest rate if you enter a long position buying the USD/JPY. Then, at the end of the month/year, you reinvest the profits and by doing that, you increase your position’s size.
Obviously, when the currency of the high-interest-rate country rises in value, the trade works even better (which, in most cases, the high-interest rate currency strengthens vs the low-interest currency).
For instance, USD appreciated in 2022 versus most currencies, particularly the Japanese Yen, which helped the USD/JPY pair reach new highs. In that case, if you bought the USD and sold JPY, you would have earned the interest rate differential and the upward movement of the pair.
3. Asymmetric Compounding Strategy
If there is one strategy that can compound your growth on a fast lane, it’s asymmetric compounding. It is a powerful strategy that you don’t hear a lot about.
In forex trading, an asymmetrical strategy refers to an approach where the potential profits made from FX trades are much larger than the potential losses. Therefore, you must have a higher win rate and need consecutive trading days to make this strategy work.
The idea is to take a trade that will generate a higher return than the risk taken. So, in a certain way, it is similar to the roulette black and red double-down strategy. It’s a great technique, and if you have the capital and you learn how to utilize proper risk management and use a forex trading plan template, then you are very likely to make consistent profits by using this strategy. But, on the other hand, it is also a very risky strategy.
Asymmetrical means the reward is two, three, or four times the risk. But every time you make a profit, you increase your risk per trade.
For example, let’s say you risk 1% per trade and use a 1:2 risk-reward ratio. If you lose the trade, you risk 1% again on the next trade until you reach the starting capital level. If you make a successful trade, you gain 2% and add it to your account. On the following day, you use the initial balance and raise your risk per trade to 2%. If you have another profitable day, then you do the same, and your risk per trade would be 4%.
This is how it works:
Let’s say you decide to risk 1% per trade with a 1:2 risk-reward ratio on a $1000 capital account.
- Day 1 – 1% risk per trade, 2% gained = $102.
- Day 2 – 2% risk per trade, 4% gained= £1060.8 capital
- Day 3 – 4% risk per trade, 8% gained= £1144.8 capital
That’s what the asymmetric compounding strategy is all about. As you can see, it is an excellent risk management strategy, although, at the end of the day, you must make more winning trades than losing ones.
Take note that there are no strict rules for using the asymmetric compounding strategy. For example, if you wish to take a safer approach, you can go back to risking 1% after three profitable trades. It’s all up to you and what level of risk you are willing to take.
Forex Compounding Strategy – Pros and Cons
For some, compounding can be a Godsend; for others, it can be challenging. So let’s see the forex compounding strategy’s pros and cons.
- Compounding allows you to grow your trading account exponentially, potentially leading to significant gains over time
- A well-defined trading plan and focus on high reward-to-risk trades can help you consistently generate profits, which can be compounded over time
- Trades can use different forex compounding strategies
- Compounding can magnify gains and losses, so proper risk management is critical to avoid excessive losses
- With compounding, it takes time to generate significant results, so you must be patient and willing to wait for investments to grow
Forex Compounding Plan Google Sheets (FREE)
Feel free to visit the link below and make a copy from our Forex Compounding Plan Google Sheet or edit the editable fields to get estimations on your trading account balance.
Forex Compounding Plan Excel Spreadsheet
BONUS: Forex Compounding Plan PDF (Download)
In this section, you can download our free Forex compounding plan PDF which includes two Forex compounding strategies:
- Forex compounding strategy with an interest rate
- Forex compounding strategy daily pips target
FREE Forex Compounding Plan PDF
On the button below, you can download our FREE Forex Compounding Plan PDF
In Summary – How Compounding Can Help You Grow Your Trading Account Faster?
The bottom line is that forex compounding is a powerful trading strategy that can help you achieve your goals. With a disciplined approach, controlled risk, and a focus on high reward-to-risk trades, compounding can be the secret ingredient for explosive growth in your forex trading account.
To take advantage of compounding, forex traders need to have a well-defined trading plan and a focus on proper reward-to-risk trades. Additionally, compounding can also magnify losses, so good risk management is critical.
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