Trading: the magic of compound interest

The more frequently your money earns interest, the faster your account will growth. This is the principal of compound interest, create value over time. But, how can we use this powerful tool to create wealth in short period of time? Here is when day trading comes to play. We can achieve same results of more than 20 years of long term investment with a couple years of daily trade. To understand how this is possible we need to start from the beginning and review the formula of compound interest.

How to calculate compound interest:

Compound interest is calculated by taking the amount of money invested or principal, the interest rate or percentage of return, time period and compound frequency.

Compound interest formula:

A = P (1+r/n)^nt

A = Total investment value in the future after including interest earn.

P = Principal, or amount of money invested at the fist period without any internet earn.

r = Interest rate in decimals.

n = Number of times interest is compounded in a year.

t= The number of year the money is invested.

The benefits of compound interest.

To have a clear view of the benefits of compound interest we need to compare it with simple interest first. Simple interest accumulated interest is not added to the principal amount for the next period. On the other hand, compound interest is the result of reinvesting interest. .

Let’s assume that you are planning to day trade stocks or cryptocurrencies and you have $2000 to start trading. In the first scenario we will use a simple interest approach cashing out the profits on every trade for next 100 trades. For both scenario our average trade margin is 2%.

Compound interest formula and trading.

In order to apply this formula when calculating trading earnings “t” would be the number of trades completed. The interest “r” would be the average interest from the “t” trades completed and “n” would be equal to 1. To have better understanding of the formula review the example below.

Assuming you have a capital of $1000 (P) that you want to use to start your trading path. You have been practicing for several months and your average return on your trades is 1.75% (r) and you will like to predict how much money can you make after completing 300 (t) trades. With this information we can calculate the future value of the investment after the selected number of trades.

A = $1000 (1+0.0175/1) ^1*300

A = $1000 (1.0175) ^300

A = $1000 (182.11)

A = $182,110

The magic of compound interest and trading.

Is important to understand that day trading is different from gambling. Day trading is a profession and as so it needs knowledge and it take time to develop the skills to profit from it. Same as an engineer or a doctor who spend 4+ years studying and development skills. Day trading requires the right tools, education, practice and resources. It also requires many hours of reading books, watching YouTube videos about different strategies and different trading styles until you are able to find which works better for you.

An average successful trader can make between 1% to 2% on each of his trades every day. That means if you have a buying power of 20,000$ you could make between 200$ to $400$ on a daily basis. That is equal to 4,000$ to 8000$ a month, which is equal to 48,000$ to 96.000$ a year.

In the chart below you can find how profits depends of buying power on different periods of times.

Buying power table.

As you can see your profits depends directly of your buying power. But do not discourage if you don’t have enough money to start. Some traders started with less than 500$. If you are able to day trade as a second job you can achieve same goals. Probably you are asking, how with just 500$ can I make more than $100,000 in one year?.

One of the more powerful tools its call compound interest. As Einstein said “Compound interest is the eighth wonder of the world, he who understands it, earns it … he won’t doesn’t … pays it”. If you achieve a high degree of discipline you can become a successful day trader just with a few hours a day. How? Let’s go to the numbers.

Let say you have a job, and you do not need extra money to cover your bills and expenses. Then, you have $500 to start your journey as a day trader. If you reinvest your daily profits as a daily basis you could make more than $55,000 just in your first year. In the chart below I will show you how this is possible.

Trading simulation for 365 days

As you can see on the chart, if you complete 240 successfully trades with an average of 2% return on each trade you could make more than $55,000$ with just a $500 investment. If you continue up to 365 trades with the same average return of 2%, you would be making more than $680,000.

But remember complete 365 successfully trades in a row is practically impossible. If you achieve to become a profitable good trader, you would be able to have a ratio of 3/1 or 4/1. This mean that for each 4 or 3 trades completed you would fail in one of them.

Benefits of day trading

What makes day trading even more attractive is the lifestyle. You can work from home, work just a few hours during the weekend and take days off whenever you wish. Also, you can spend more time with friends, family or just enjoin things that you like. Also, as a day trader you are able to move your job everywhere in the world, you are able to travel and move to other countries and still making money.