All You Need to Know About Compound Interest

Compound interest is a great way to boost your investments, and for a serious trader, it’s important to understand what this type of interest is and how it works. Featured in many portfolio strategies, compound interest is about continuous long-term investment, instead of a quick withdrawal of profits. Traders using this technique can see a huge growth of capital over compounding periods, even when beginning with small amounts. So, if you’re a trader looking to a compound interest strategy for your investments, here’s all you need to know.  

Compound Interest Definition 

The process of compound interest means when extra capital is earnt from the original deposit in an account or investment, as well as any further income and procured earnings. This happens over a certain amount of time called a compounding period. The theory is the longer the plan of investment, and therefore more compounding periods, and the lesser the amount is withdrawn, the bigger the profit will be from the compound interest. This is different from simple, linear interest, where only the original amount earns interest over time. For compound interest, the investment increases exponentially. 

Compound Interest and Markets

Compound interest is an integral part of a traders’ technique and tactics. When it comes to the stock and shares market, some companies offer a compound-style reinvestment scheme, for the dividends that investors can receive. This is known as mutual funds. They offer the ability to reinvest the cash dividend, in order to purchase additional assets, with more compound interest accumulating over time. This results in compounding profits, as the more the trader re-invests in the shares of the company, the more income they will receive from future dividend pay-outs and help the investment grow in value; creating a continuous cycle of payments, profit and reinvestment. 

Compound interest can also be applied to those who have a trading account; the main account in which a trader holds all of their securities and capital for investment. In this case, the money being held works in the trader’s favour, as they increase their gains from the interest earnt, depending on their win rate, the average position size and the average reward to risk ratio they implement. The compounding period for this type of account can be continuous, daily or annually. A day trader, for example, can profit from reinvesting their gains at the end of a trading day, into a daily compound-interest trading account; accumulating exponential growth from the daily income and interest, instead of withdrawing any profits at the end of each day. 

Compound interest is particularly beneficial when online forex trading on Plus500, for example, as gains can be achieved when there are different interest rates between the two currencies in a currency pair.  

Factors That Affect Compound Interest

The patience, consistency and the interest rates that will be involved, are all things to consider when it comes to compound interest. It may seem like a tedious process, but compound interest is a long-term investment. After a seemingly slow start, once the trading account reaches a significant amount of money, there will be a huge rise in the return of investment. Therefore, it is important to be patient and maintain this trading strategy for a long period of time. 

A consistent performance is also key to benefiting from compound interest. There needs to be continuous deposits and reinvestment into the account or mutual fund in question, in order to fully reap the rewards and see a growth in earnings from the interest. 

The interest rate of the account is also an important factor that can affect this process. Usually, a higher interest rate means that more of a percentage of earnings will be received, and so a faster and wealthier growth of income. This should also be taken into consideration alongside the length of time and number of compounding periods that the account is expected to be held, and without a huge number of withdrawals of capital. It is wise to use an online compound interest calculator to fully understand the potential growth, initial deposit required and the effects of the interest rate on your investment.