by Donny Coller
I'm sure you have all at some stage heard about the amazing effects of compounding specially when it comes to finance.
In traditional markets we have what's called a Dividend Re-Investment Plan or “DRIP”, where the Dividend pay outs (Interest earned) is Re-Invested back into the market to purchase more Shares, to then make more interest on your interest.
This is commonly known as Compounding interest and is a continuous cycle of being able to infinitely print money, or simply putting your money to work to earn more money.
We use this same theory in life all the time and is the main object of investing.
When it comes to Professional trading we use a different kind of compounding where we compound our trading accounts.
Any professional trader will generally work on a risk management plan where we only risk around 1% of our account per trade.
As an example if your account size is $10,000 then each trade you place will come with a risk of losing $100 which is 1% of your Account.
If your trades are on average a Risk to Reward ratio of 2:1 that means you will win $200 or lose $100
Now over time as your account balance grows, your position size or risk per trade will also grow and so will your potential wins.
As an example if your account has grown now to $15,000 then a 2:1 trade will now be a loss of $150 but a potential win of $300 using the same 1% risk plan.
Typically we would aim to increase our account size by a specific obtainable % each month, to give our selves a benchmark or goal to achieve.
It doesn't take a genius to understand the potential for compounding here and how your account can grow exponentially using a pre set risk % per trade.
I have added a link to a really handy calculator that you can see for your self and muck around with.
How to use:
1. Input a starting balance amount eg. $10,000
2. Input a % increase of your entire account per month eg. 5%
3. Input a date range to see the potential earnings over that time period eg. 24 months
Ok super cool stuff right?, but that's not what I wanted to show you today. Today I wanted to show you the benefits of compounding your base currency for buying power in the market you’re trading, more specifically….. Compounding in the Crypto Market.
If you haven't read the 3 part series I recently released on “How to trade the Crypto Market” I suggest you read them as well, as this ties it all together.
Part 1 > Correlation Diversification
Part 2 > The Arbitrage Triangle
Part 3 > Beat the Benchmark
Its often a common debate and question I'm asked on a weekly basis, and although everyone has there own theories and opinions, today we are going to be looking at historical data and putting 3 strategies to the test to see for ourselves how they perform long term.
Does that mean there is a RIGHT or WRONG way of trading the Crypto market?
The answer is… NO, everyone has a different way of doing things, or a different goal to achieve and that's ok.
Some people dont understand the correlation in Crypto or care much for it, and others simply chose not educate them selves around the topic and are happy doing things their way.
So on that note lets begin our simulation trading for SATS or DOLLARS
In this simulation we are going to be using the Bitstamp chart of BTC/USD as it has the most technical data we can use dating back to 2011.
We are going to be basing this simulation using the Compounding trading account theory we used above with a starting capital of $1,000 AUD.
We all know as traders we have good months, and we have bad months, and although we may have the odd 10–15% month, its not uncommon to have bad months where we may go backwards by 5%.
So to keep a realistic expectation or benchmark we will use 1% per month.
The 3 simulations are listed below.
SIM 1. Starting with $1000 AUD, converting to USDT and trading consistently for 1% increase per month to current date, accumulating only USDT.
SIM 2. Starting with $1,000 AUD, converting it to BTC and trading consistently for 1% increase per month to current date, accumulating only BTC.
SIM 3. Starting with $1,000 AUD, converting it to BTC and trading consistently for 1% increase per month to current date, however accumulating only BTC when we have a bullish bias, and then converting and accumulating USDT when we have a bearish bias
(check this article here to know what I mean > Trending Market Bias <
SIM 1: In this simulation we can see a pretty consistent rise on account balance to $3,354 USD.
During this time we have seen some fluctuation and volatility with the AUD against USD, but still over all a low risk option and a good 430% increase on our account over roughly 10 years of trading…. Noice
SIM 2: In this simulation we can see a consistent rise in our BTC amount, how ever the fluctuations with the price of BTC, saw our balance go backwards at times…. eeekk. The compounding effect with the rise of BTC has seen absolutely phenomenal gains over the past 10 years, with a final account balance of over 18 MILLION DOLLARS!!!! …Say whaaat???
SIM 3: And finally we come to my trading strategy of only trading for BTC during bullish market bias and then switching back to USD, during bearish market bias.
This type of strategy never catches the tops or bottoms, however you can see overall that by switching your bias with the trend you can absorb the long term volatility or direction in the assets value.
The end result after 10 years using this basic strategy of trading with a bias of the base asset is a staggering 74 MILLION DOLLARS !!!! …… THE F@&K?
Still think its not worth learning this stuff?
Ok ok ok I know, these results are exaggerated as no one would have done what I just simulated, I did this to highlight the effects of compounding in the crypto market, but to be honest, the majority of current crypto traders probably entered the market mid to late 2017 purchasing there first bit of bitcoin between $5,000 and $20,000 USD.
So lets put this into a more realistic perspective and run the same simulations as if you bought the top of the December monthly close in 2017.
This time starting with a more realistic balance of $10,000 AUD.
SIM 1: Trading for USD has netted you a stable return of $14,498 AUD in only 3 years, keep this up and that will compound nicely over time.
Luckily for you the AUD has recovered its strength against the USD in the last 12 months other wise you would have been basically FLAT…. douh
SIM 2: Buying the close of December with $10,000 aud would have scored you roughly .55 BTC.
You would have seen your aud value drop significantly shortly after and probably thought about giving up… “bloody ponzi, knew I shouldn't have listened to davo”
However with the return of positive price action and the current conversion rate of USD you are now sitting pretty comfy on a bit over 40 thousand dollars Australian and can almost call yourself a “Wholecoiner”.
Now that….is a good solid 3 year return if you ask me, give yourself a pat on the back Mr strong hands.
SIM 3: And finally we run the sim using my bias strategy again by switching out your base asset during different market trends.
Even accounting for not catching tops or bottoms, there is a significant increase on your BTC holdings which is now netting you over 110 thousand dollars Australian in just 3 years time, putting you in the 6 figure club…. chur boi!
This is over a 1000% gain from your original investment or in the words of Grant Cardone — “you just 10x’ed your port folio my friend”.
Statistically it is proven more profitable to trade for sats in the crypto market. As the base asset rises in price your realised profit is compounding as well.
How ever this is only FACTUAL if the price of Bitcoin continues to rise or stay high.
If we start to see a significant pull back to low teens this will not be true.
So trading for sats brings risk of volatility from the base asset, how ever since the creation of Bitcoin until present date its still FACTUAL.
Its ridiculously more profitable to switch your bias with the overall long term trend of the market and harnesses the best of both worlds.
Compounding the base asset during bullish trends and absorbing the volatility with a stable currency when the trend turns bearish.
There is no right way, there is no wrong way….there is more efficient ways, and there are more profitable ways, there are also less confusion ways, less risky ways and there are the ways that you like to do it.
What is important, is that you educate yourself and understand the market and have an open mind to doing things differently than you have always done before.
At the end of the day you will find a strategy that works for you and makes you profitable and that is the real goal here.
Ill finish this article up with a quote from the great Albert Einstein.
Compound interest is the eighth wonder of the world.
He who understands it, earns it; he who doesn’t, pays it.