What is Compound Interest? (plus free calculator)

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I want to share with you something that has always been very inspirational for me. It’s something I have always kept in the back of my mind when trading. It’s called “Compounding Interest”.

Let me explain with an example what it means. Imagine you have one dollar and double it each day for 30 days. With how much will you end up after one month? Hundred dollars? Thousand dollar? Ten thousand dollars? No, if you double $1 for 30 days, you will end up with over 1 Billion dollars….

”Compound interest is the eighth wonder of the world.
He who understands it, earns it … he who doesn’t … pays it”.

Albert Einstein

It is all about interest upon interest, growth based upon growth. So each time you get interest, it’s not only your original dollar that collects the interest, but all the dollars you received as interest are also collecting interest. One dollar becomes two , two dollars becomes four, four becomes eight, eight becomes sixteen, etc. etc. The growth builds up, it is compounding.

Let me show you the chart below first to give you an idea of the difference between normal interest and compound interest:

The most important characteristic is that compounding interest is giving us exponential growth. Its is essentially growth based upon growth.  Let me explain how I calculate this in the following examples. The first example is normal interest:

I start with $500, I make 300 trades, winning 3% in each trade.
500 + (300 * (500 * 0.03)) = $ 5000

The next example is exactly the same, but now compounding the interest:

I also start with $500, I also make 300 trades, also winning 3% in each trade.
500 * (1.03 ^100) = $ 3 549 256

You see this is a big difference, $5000 or $3.5 million. Of course these examples are hypothetical and only consist of winning trades, but it illustrates the potential power of compounding interest.

Although compounding interest is exponential, you will probably be in the horizontal/small growth phase for a long time. It takes time to get to the vertical/ big growth phase. I once heard a trader say: “It took me 10 years, to become an overnight success”. So a very important skill for a trader is having patience.

Here you have a compounding interest calculator. Just fill in the principal amount to start with. The profit you make per trade, and the total number of trades to be made.

Of course these results are for demonstration purposes only. In real trading you will encounter losses, losses are an integral part of trading. Real trading demands proper risk management. This calculator serves purely as a demonstration of the theorem.

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