by Christopher Butcher, 17/08/2017
I get the question all of the time – “how big is your trading account?”
A question like this would normally come from someone inexperienced and uneducated in the true ways of how successful trading should work.
Amateur traders and those from an outside perspective will instantly associate trading with the large amounts of money to made. A professional and experienced trader has a completely different outlook – they will be more focused on protecting the money they don’t lose. The theory here is if you minimise your potential losses, then your winners should take care of themselves. It’s a business model.
Now the idea of “monetary value” is completely irrelevant when it comes to trading because this is a percentage game. The reason for this is to allow for compounded returns, which Einstein described as the most powerful thing ever created by mankind.
Let’s see why percentages are so much more important than “value”. Below we compare what happens to a £5,000 account over 2 years if you make £500 per month versus 10% per month.
A fixed return of £500 means that the monthly profit stays the same throughout.
So after 24 months, the account balance has gone from £5,000 to £17,000.
However, if the monthly return is based from percentages...
Initially the returns are very similar. However as time goes on, the growth itself is growing and the differences become bigger and bigger.
Obviously, it's very clear where there is more profit to be made over time but how does it work?
Well let's say we make 10% on £1000 - the return would be £100, and the account balance would then stand at £1100.
If we make another 10%, we now apply that return to the bigger account size of £1100. So the next month's return is bigger at £110.
So in other words, the growth itself is growing at the 10% rate of return.
This is called exponential growth and highlights why we should try to leave our account balances alone to grow naturally over time.
The longer we allow the exponential growth to be applied to our accounts, the bigger the returns become. And if we look back to our first example and apply the same growth on a year-by-year basis, the returns would look like the following :
And so in understanding how powerful exponential growth really is, all we have to do is think in terms of percentages rather than value.
In trading it's very easy to get emotional if you compare the money you're trading to real-world monetary things. And this is a big hurdle all traders must overcome.
I'll leave you with a quote from Einstein...
" Compound interest is the eigth wonder of the World.
He who understands it, earns it. He who doesn't, pays it. "