Compounding Your Trading Profits: A Fixed Fractional Tutorial

I'm never sure if I'm making an obvious observation or not. But even if I am, this one comes with a cool chart. So here goes: if you're not compounding your trading profits by increasing trade sizes as your account balance grows, you should look into it. Using what's commonly termed a "fixed fractional" trade sizing system, a consistently successful trading strategy can become exponentially successful. Let's say you have a trading system that brings in $20 per trade when you first get started. Over the next 1000 trades, if you keep risking the same amounts as when you first started, you'll make $20,000. However, if you increase the amounts you're trading proportionally to the increase in your account balance, you'll make substantially more.

If you started with $1000, let's say you double that to $2000 after 50 trades. Using the fixed fractional system, you now double your trade sizes, and as a result are making $40/trade - and you're maintaining the same level of risk, since you're continuing to trade with a "fixed fraction" of your total funds. After another 50 trades you've doubled your account size again, to $4000. Time to double your trade size again - so now you're making $80 a trade.

You're now tapping into the power of compounding, and you don't even need to take on unreasonable or increasing levels of risk for it to work, since you're always risking the same percentage of your funds in every trade. That percentage is up to you, and should be one that allows you to weather a periodic (and inevitable) losing streak with your account intact. Keep in mind that during a losing streak you'd scale back your trade sizes as well - so if you end up with just your original $1000, you'll be back to $20 trades.

Here's a chart of what the difference between a compounding, fixed fractional strategy and a non-compounding strategy looks like over 1000 trades, assuming you're averaging $20 a trade to start with. Unlike the example above, which compounds every 50 days, this data is based on compounding after every single trade.


See that blue smudge at the bottom? That's the $20,000 non-compounded total. Sorry it's so hard to see...the scale is skewed a bit by the $1.4 million gains from compounding.

Again, this may be completely obvious to everyone, but isn't that graph fun to look at?

PS: Obviously exponential growth can't continue forever and if your account balance grows absolutely gigantic you won't be able to fill your orders or you'll be moving the market to much to profit when doing so. But I just file those issues under Good Problems to Have.

Related topic:
Forex Calculators & Converters