A guide to compound interest and how it works

If you’re an experienced business trader, then it’s important to understand the benefits of compound interest and how it works. It can be a great way to accelerate your savings and investments, over a long-period of a time. 

How does it work when trading?

There are many strategies that you can use when trading and investing, and when it comes to compound interest, this can work in your favour depending on the market you focus on and the type of account you hold. 

This type of interest can be found when stock trading, and takes the form of a re-investment scheme, known as mutual funds. This means companies can offer the opportunity to reinvest any dividends received. Through this reinvestment, traders can purchase additional assets. 

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As a result, compounding profits can occur. With more investments and shares of the company and question, the more dividends are then received in the future, and more opportunities to reinvest in the company — create a cyclical compounding effect. 

What factors affect compound interest? 

The first aspect relates to the composure of the investor. As all experienced investors know, having emotional control is imperative to successful trading. The same applies when it comes to compound interest. Patience is key, as the gains from compound interest can be seen over a long-period of time. At first, it may seem that there is little movement in your account, or a significant amount added to your capital. But, over a sustained period of time, you can see a huge increase on your investment, where any original capital and additional earnings have gained interest. 

Consistency is also another factor. If you are tempted to withdraw numerous times from a trading account, or do not continuously reinvest into a mutual fund, then you may not see as much growth from compound interest. You should aim to consistently add deposits or reinvest, to see the effect of compounding. 

What is compound interest?

Compound interest happens when additional payments are earnt from the original investment in an account, as well as any further deposits or earnings accumulated. Essentially, you can earn interest on your interest with compounding. 

This differs from simple or linear interest, where you only earn interest on the original amount, and any further earnings are not taken into account. 

The compound interest is calculated over a certain period time, known as a compounding period. This means that over time, with more compounding periods and the minimum amount withdrawn, the more you can earn in interest. 

By using compound interest effectively, you could see an ever-increasing growth on your investments over compounding periods — even if you begin with a small amount of capital. With this in mind, let’s explain everything you need to know about compound interest. 

This type of compounding is only effective with traditional stock trading, and not through a financial derivative such as a contract for difference (CFD).

When CFD trading, you do not own the underlying asset, and therefore with stock CFDs, you are not entitled to any dividends or additional benefits. 

As previously mentioned, compound interest is most commonly found with a trading account. Any capital held in a trading account with compound interest will exponentially increase over time, in accordance with the win rate of the investor, the average position size and the number of withdrawals. 

The compounding period can vary for a trading account, and can be daily or annually. Therefore, if you are a day trader, you can benefit from holding your capital in a trading account with daily compound interest, instead of withdrawing any profits at the end of the day. Any gains you made from your day of investing, can grow from the daily interest added. 

Finally, the interest rate itself can impact the amount you receive from compounding. In theory, the higher the interest rate, the better percentage you gain from your investment, and the faster your wealth will grow. However, the interest rate is not the defining factor, and should be considered alongside the length and number of compounding periods, alongside how many withdrawals from the account you are likely to make.