COMPOUND INTEREST | Time is on your side📚

9 cze 2022

❗️As it turned out, not all traders are familiar with such an important concept as compound interest. Meanwhile, the use of compound interest in trading can be a very effective tool for making a profit. In short, compound interest is the accrual of interest on interest, and if in detail, then read on.

✅The formula for calculating compound interest has the form:

Compound percentage = (P (1 + g)^ n) – P, where

P – the amount originally invested;

r – interest rate;

n is the investment period.

Let's say you invested an amount of $ 10,000, every year the interest received is added to the principal amount, and new interest is accrued for a larger amount. If the investment period is 5 years, and the interest rate is 10% per annum , then after the specified period, taking into account the compound interest, you will receive a profit in the amount of:

(10000(1+0.10)^5)-10000=6105.1$

And without taking into account the compound interest, the profit for the same period will be:

1000050,10-10000=5000$

As you can see, using compound interest (or in other words reinvesting profits) brought additional income in the amount of: 6105.1-5000 = 1105.1 $.

✅It seems that the figures presented above are not impressive, but the use of compound interest in trading can truly work wonders. In what way? Let's take another look at the compound interest formula described above. It is obvious from the formula that you can increase profit by increasing any of its components. Let's not touch the amount originally invested, but play with the value of the investment period and the interest rate.

To begin with, let's imagine that we will reinvest the profit not every year, but every month. Then the investment period will be 12 5 = 60 months. The interest rate corresponding to this investment period will be equal to: 10%/12=0.833%. Let's substitute these values into the formula for calculating the compound percentage:

(10000(1+0.00833)^60)-10000=6449,8$

As you can see, under the same conditions, but with monthly reinvestment of profits, the income will already be $ 6449.8- $6105.1 =$344.7 more.

Well, if the trader's income is not 0.833% per month, but, for example, 5% monthly, then under the same conditions and for the same period, the profit will already be:

(10000(1+0. 05 )^60)-10000=176791,86$

Felt the difference, impressive, isn't it? And what if you reinvest profits not monthly, but daily? Let's figure it out. With an average yield of 5% per month, the average daily yield will be 5%/21= 0.238% (here 21 is the number of working days in a month). The investment period will be 5360=1800 days. Let's substitute the data into the compound interest formula:

(10000(1+0.00238)^1800)-10000=711617,5$

This is already 711617.5-176791.86 = 534826 $ more than with monthly reinvestment of profits. More than half a million dollars (and this with an initial investment of only ten thousand)! That's impressive. That's what compound interest is in action.

⚠️This is about theory. In practice, it is impossible to achieve a constant percentage of profit every day. Some days a trader inevitably ends up with a loss, some with a profit, and the size of these losses and profits is always different. So it is unlikely to substitute the value of the percentage of profit per day in the above formula. However, the very essence of compound interest, clearly shown above in figures, gives the trader a fairly powerful tool for earning. A trader can and should use compound interest when creating his own money management system.

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