The True Power of Compounding in Trading

Compounding is one of the most powerful force in finance, yet most retail traders never truly experience its full potential. In trading, compounding means letting your profits build on top of previous gains, allowing your account to grow faster and faster over time. But how does this work in practice, and how can traders harness compounding while minimizing risk?

In this article, we’ll start with a simple example that anyone can understand, then progress to more realistic scenarios with real-world strategy statistics. Finally, we’ll see why trading a portfolio of uncorrelated strategies is the real secret behind consistent, exponential wealth building in trading.

Simple Compounding: Fixed Bet vs. % Risk Example

Let’s start with and example that you have surely seen some variant of before. We have two traders, both beginning with $10,000 and earning a steady 2% profit per month:

• Trader Fixed-bets: Trades the same position size each month, taking $200 profit every month (2% of $10,000).
• Trader Compound: Reinvests profits after each month, earning 2% on the current account balance each month.

Month	Trader Fixed (No Compounding)	Trader Compound (Compounding)
Start	$10,000	$10,000
12	$12,400	$12,682
24	$14,800	$16,089
36	$17,200	$20,412
48	$19,600	$25,913
60	$22,000	$32,973

After 5 years (60 months), the compounding trader ends up with nearly $33,000, i.e. 50% more than the fixed-size trader, who finishes with just $22,000.

In the above example, we used a simple % risk approach where profits are reinvested only once per month, that is, position size is adjusted at the end of each month based on the new account balance. This is a straightforward way to compound returns, but it’s still only scratching the surface.

In the next section, we’ll explore a more realistic scenario for algorithmic traders: adjusting position size and compounding after every trade. As you’ll see, this approach takes full advantage of the compounding effect and leads to even more powerful growth over time.

A More Realistic Scenario: Compounding in Action

Let’s take a look at a scenario based on how real-world traders analyze their strategies. Suppose you have an algorithmic strategy with these statistics:

• Win rate: 50%
• Average win: $150
• Average loss: $100
• Number of trades per month: 20
• Starting capital: $10,000

Trader A always risks $100 per trade (fixed lot size). Trader B risks 2% of their current balance on each trade (compounding). Both run the same strategy for 3 years.

Month	Trader A (Fixed $100 Risk)	Trader B (2% Risk Per Trade)
Start	$10,000	$10,000
12	$16,000	$31,384
24	$22,000	$98,539
36	$28,000	$367,800

So, trader A (Fixed bet) earns a steady $500 profit per month (20 trades × $25 average edge per trade), so their account grows linearly. Trader B (% risk), on the other hand, benefits from “betting bigger with house money” every time their account grows, so each win or loss is 2% of an ever-increasing balance. Over time, this creates exponential growth.

Fantastic, right?

But in real trading, your monthly results will fluctuate. Losing streaks, winning streaks, and market regimes can all impact your growth. However, the core principle stands: compounding with positive expectancy leads to explosive long-term results, far beyond what’s possible with a fixed bet size.

Let's explore this with one of our own EA strategies for Gold, "Gold Miner II for MT4 and MT5". Here are 2 equity curves, the fist using a Fixed bet size of 0.2 lots and the second equity curve uses a % risk bet of a moderate 0.5% of the account balance. 

Fixed bets - 0.2 lots

% risk of 0.5% per trade

In both examples we start with a $10k account, and the first trade in both cases use a 0.2 lot size (same starting point). Now, there are a couple of things that the observant reader will notice:

1. The final equity is around 3 times larger for the % risk backtest. This is as expected, because the strategy have a real edge, and the bet size will increase as our account grows, hence our profits will be larger.
2. The equity curve is a bit smoother for the Fixed bet backtest. Also expected, as when our bet size increase, a series of loosing trades will set us back more with a % risk money management. We'll explore how we can mitigate this with a portfolio approach in the following section.
3. Even with a % risk setting, the capital "only" grew from $10k to $65k over a 17-year period. While this is true, we have to take into account that the strategy had a market exposure of only 1.48%, meaning that it was only in a trade around 1.5% of the time during these years. The question that you should be asking is; "how could we have let our money work for us the rest of the 98.5% of the time?". We'll also explore this in the next section.

Why Portfolios Supercharge Compounding

Most algo strategies, even those with a really strong edge, eventually face tough periods, meaning drawdowns when the strategy underperforms or market conditions change to conditions that are not suitable for that type of strategy. This is where the concept of a portfolio of uncorrelated trading strategies becomes a game changer.

Drawdowns: The Hidden Enemy of Compounding

Drawdowns aren’t just frustrating, they’re the enemy of compounding. Large losses require even larger gains to recover, and long losing streaks can demotivate traders or lead to poor decision-making. But what if you could make your equity curve smoother and minimize these tough periods?

The Power of Uncorrelated Strategies

Suppose you run just one trading algorithm. You’ll likely experience big swings in your account balance as your edge plays out over time. Now imagine you run five different strategies, each with a long-term edge but totally uncorrelated, meaning they don’t win and lose at the same time.

• Each individual strategy might have drawdowns lasting several months.
• When combined, however, your portfolio’s total drawdowns are often much smaller and shorter, as some strategies zig when others zag.

How Does This Impact Compounding?

Let's explore this with a direct example with one of our own selected portfolios! 

The EAs in the portfolio are long only, the only trade Gold (XAUUSD) and only trade on the long side (i.e. they work well for US traders that are not allowed to "hedge"). Here are the EAs we'll use:

• Gold Miner II
• Gold Miner IX
• Gold Miner VIII
• Gold Miner X
• Gold Miner XV

These strategies are totally uncorrelated with each other, in fact they have a negative correlation to each other most of the time:

Correlation between strategies on a monthly-loss basis.

The following is what happens when we add these strategies to a portfolio and trade them side by side:

Fixed bet - Portfolio

% Risk - 0.5% per trade - Portfolio

% Risk - 1% per trade - Portfolio

The benefits are profound:

• Higher final equity: with the 1% risk per trade backtest, we see the exponential factor start come into play and the final equity is more than 7x compared to the Fixed bet example.
• Smoother equity growth: Reduced drawdowns mean your account spends more time making new highs. Even at 1% risk, our equity curve is fairly smooth, meaning we can comfortably take this risk without having to live through lengthy draw down periods.
• Reduced risk of ruin: Smaller drawdowns protect your capital, allowing you to keep compounding.
• Higher risk-adjusted returns: You may be able to safely risk more per strategy, compounding even faster, because overall risk is spread out.

Now, in our portfolio we're running 5 different non-correlated EAs. Running five EAs simultaneously, will mean a higher exposure to the market, yet with this specific portfolio we're only exposed to the market 3.12% of the time. Again, we should ask ourselves; how could we make our money work for us the rest of the of the time? Hint: the answer is - add more non-correlated EAs to our portfolio!

We should also compare our portfolio of strategies to a reasonable alternative, for instance staying invested in an equity index (commonly used as a comparison to evaluate strategies/portfolios). 

Comparison: our portfolio of EAs vs SPY ETF 

In the above chart, we can see that our small portfolio of 5 EAs outperformed the buy-and-hold strategy of the SPY (full name: SPDR S&P 500 ETF Trust) ETF (yellow line). 

But it becomes even better, because with our portfolio, we were only exposed to the markets around 3% of the time vs with the buy-and-hold of the SPY ETF, we were exposed 100% at the time and went through several severe drawdown periods of up to 34%, compared to a meager drawdown of only 14% with our portfolio.

Considering the low exposure of our portfolio, which mean that we can make our money work for us even better (adding more uncorrelated EAs to our portfolio), a more relevant comparison would be to also take the market exposure into account. Let's normalize the equity curves by exposure, meaning we'll give the same exposure to both strategies (our portfolio vs the SPY ETF):

This more "fair" comparison tells the true story that most investors don't realize: that the Holy Grail in trading lies is the combined effects of % risk and portfolios.

For a deep dive into why portfolios matter, see our article: Why Successful Algo Traders Trade Portfolios

Takeaways: How to Harness the Power of Compounding in Your Trading

The examples above make one thing clear: compounding transforms trading results from average to extraordinary. Here’s how you can take full advantage:

• 1. Use % Risk Position Sizing: Risk a small, consistent percentage of your account on each trade (such as 0.5-2%), rather than a fixed lot size. This lets your wins build on themselves and controls losses during tough periods.
• 2. Run a Portfolio, Not a Single Strategy: Seek to combine multiple uncorrelated strategies. Even if each strategy is average, the portfolio effect smooths your equity curve and dramatically improves risk-adjusted returns.
• 3. Avoid Overleveraging: Compounding is powerful, but taking excessive risk increases the chance of a large drawdown or “blowing up” your account. Let the math do the work; don’t force it.
• 4. Be Patient and Disciplined: The true benefits of compounding are only seen over longer timeframes. Avoid the temptation to “take profits out” or jump from system to system. Stick to your plan.
• 5. Track Results: Use a spreadsheet, trading journal, or performance-tracking tool. Seeing the growth and understanding the impact of drawdowns will reinforce why you follow this approach.

Final Thoughts

In trading, time and discipline are your allies. Most retail traders underestimate how dramatically compounding can accelerate returns, especially when combined with the risk reduction of a well-designed portfolio. Start small, keep your risk in check, and let the power of math work for you.

If you want to experiment and see these effects for yourself, try our Variable Risk Position Size Calculator or play with the Freedom Calculator to see how fast you can get there.

Compounding isn’t magic, it’s just math. But in trading, it’s as close as you’ll ever get.