Compound interest and online trading: how to calculate
Published: 31 May 2021 by Andrew
Many of you have already heard of compound interest but it is often associated with rates of return so low that you don’t pay much attention to it. In reality this mathematical principle can create wealth if applied to online trading, let’s see how.
To understand how to apply compound interest to trading, we need to analyze every aspect of it. OnlineTradingCourse.net has become the reference point for online trading and this guide will show you a very profitable investment strategy linked to the compound capitalization scheme.
The main characteristics of compound interest are:
|Type of investment:||Long term speculative|
|Formula:||C = i (1 + T ) ^ P|
|Who can use it:||Everyone|
|Minimum investment required:||100 €|
|Best Strategy:||eToro CopyTrading|
But before delving into mathematical calculations and formulas here is a list of the best brokers (with licences and authorizations) that are the basis of any investment, among these we immediately mention eToro which is the only one to offer the perfect automatic investment system (called Copy Trading) when combined with Compound Interest.
Compound interest: meaning
What is compound interest?
Compound interest is interest over interest. In other words, we can define it as the percentage of interest, calculated on the capital plus the interest accrued up to that moment.
Having said this, the concept of interest capitalization may seem complicated but it is not, to simplify it we must compare it with the concept of simple interest.
Simple interest is not added to the capital and therefore does not contribute to its growth, but is usually withdrawn.
Let’s take an example so as to clarify the concept. Suppose we have a capital of 10,000 euros on which to calculate the interest:
- If our investment yields 10% per annum and we use simple interest every year, we will have an income of 1000 euros which we will withdraw regularly at the end of each period. In the tenth year we will have accumulated € 10,000 of interest drawn.
- If our investment yields 10% per annum and we use compound interest each year, we will have an income of 10% which we will NOT withdraw but will leave on the account to increase the capital. The increase therefore takes place exponentially: in the second year, in fact, 10% will be calculated on 11,000 euros; after another year, out of 12,100 and so on, in an exponential way. In the tenth year we will be able to collect around 16,000 euros in interest.
Compound interest: formula
Compound interest is calculated by taking the invested capital, the interest rate and the time period.
The compound interest formula is:
C= P (1 + r/n)^(nt)
- C is the future capital with interests
- P is the initial principal balance
- r is the interest rate
- n is the number of times interest is compounded per time
- t is the number of time periods
Compound interest: calculation
How is compound interest calculated?
Suppose we have a trading strategy that yields 5% every week, it may seem like an unlikely return but with online trading these numbers are not impossible for a Trader who operates daily on the markets. If you want to live on an income, on the other hand, these are the numbers to aim for.
So the interest rate r is 5% or 0.05.
Let’s also assume you have an initial capital (i) of € 10,000 to invest, but you can also start with € 100, the principle is the same.
We evaluate a constant investment for one year, or 52 weeks which is the nt variable.
Now take a look at the table below:
Yes, you read that right: in a compound capitalization scheme, the total capital C that you would end up with after 52 weeks of online trading is 10,000 * (1 + 0.05) ^ 52 = 120,418 Euros!
(the formula provides for rounding so if you do the calculation it could result in a slightly different figure)
Yes, in one year you could find yourself with over one hundred and twenty thousand euros and do you know how much they would become if instead of withdrawing them you continued to invest for another year?
The capital would become over 1.5 million euros in 2 years!
Now do you understand why we were talking about the “magic” of compound interest?
But behind this reasoning there is a strategy that yields 5% per week and to find such a profitable strategy we have developed a method that we will describe in the next paragraph.
Compound interest: how to invest
We now have a clearer idea of compound interest and we can better understand its potential when used in an online investment.
To begin, let’s see what are the advantages and disadvantages of this fascinating mathematical tool, by examining the most classic investment methods.
Calling the deposit account an investment is a bit improper, in fact the yield of this type of account is so low that the interest is really low unless you have considerable amounts available.
However, the deposit account is a restricted bank account, where you leave a capital to accrue for a certain period of time (at least one year) and you benefit from interest that usually ranges from 1 to 2% per year, difficult to get rich right?
Obviously, when considering the Deposit Account, a constraint is programmed with a long time horizon (10, 20 or even 30 years) in order to benefit from an economic return that at least reduces inflation.
Also in this case we make an example to understand the “magic” of compound interest:
- A deposit account that yields 1.5% net, with an initial capital of € 10,000 will yield just over € 3,450 in 20 years thanks to compound interest.
- A current account that yields 1.5% net per annum but where interest is withdrawn every year, will yield only 3,000 euros in total deriving from simple interest.
As you can see, the difference between compound and simple interest in this case is very small due to the poor performance of this instrument.
Postal savings bonds
It is a rather dated “investment” tool that is now in little demand but has had its golden periods, when inflation was in the double digits!
Currently, the annual return of these vouchers is approximately 1% per annum, so as in the case of the Deposito Account, regardless of the interest used, simple or compound, you will not get much unless you bequeath these vouchers to your grandchildren!
Indeed, if we consider inflation it is not certain that the real value of the capital with interest will be able to keep pace with the price of money.
Invest with online trading
The investments we have examined so far do not highlight the merits of compound interest because they yield very little.
To make those opportunities interesting (the Deposito account and the Postal Coupons) it would take a capital of millions of euros available.
The third option concerns online trading which allows you to take full advantage of the characteristics of compound interest.
Obviously these are investments that involve risks, unlike those examined above, but the returns are completely different and really allow you to create wealth even starting from modest capital.
These brokers have minimum deposit thresholds of around 200 euros, so even if the risk is higher than in deposit accounts and postal vouchers, it is not necessary to invest 10,000 euros to obtain noteworthy returns and this also affects a lot in the trader’s psychology.
Best brokers for compound interest
The brokers that allow trading on the financial markets are not all the same, in this guide we only present safe intermediaries authorized by the supervisory bodies, such as Consob and CySec.
The trading possibilities offered by these intermediaries are varied and range from Stocks to Indices, from Commodities to Cryptocurrencies, etc.
Online brokers offer trading with CFDs, which are contracts that follow the performance of a stock and allow you to invest both up and down, without paying trading commissions.
To take advantage of compound interest, the best brokers available to learn how to invest in the markets are: eToro, ForexTB and Iq Option.
eToro has over 7 million active users on its platform and is one of the most trusted online brokers.
This broker is authorized by CONSOB and CySEC and allows you to trade without paying commissions.
The minimum deposit to open an account is 200 euros and its trading platform is suitable for all investors, including newbies to trading.
eToro also offers an automatic investment system called Copy Trading which, combined with compound interest, allows for excellent results even for novice investors.
To learn more about Copy Trading and Compound Interest, continue reading this guide.
Click here to sign up for free on eToro
For more details on this Broker, you can read our eToro review.
ForexTB is a broker that offers both a very simple web platform and the famous Metatrader 4, the most used trading software in the world.
This intermediary is also safe and legal, authorized by CySEC for Europe and also has the CONSOB authorization.
The offer of securities and markets is very wide and allows you to trade without paying commissions.
To improve the training of its members, ForexTB has created and offered everyone a trading course (in ebook format) for free, which teaches the basics of online trading in a simple and clear way.
Click here to download the ForexTB course for free
In addition to the course, ForexTB also offers free Trading Signals: they are timely and reliable operational indications, processed by the famous Trading Central.
For more details on this Broker, you can read our ForexTB review.
Iq Option is a broker with a considerable advantage over the competition: it allows you to open an account with only 10 euros!
Such a low entry threshold offers anyone the opportunity to trade, without risking large amounts.
Iq Option has created an educational area to offer the best possible training to investors.
This area is made up of hundreds of free video courses that explain in detail everything related to online trading, in this way you can avoid the most common mistakes that trader with little experience encounter.
This Broker provides a free and unlimited Demo account, perfect for gaining experience without risking money.
Click here to sign up for free on Iq Option
For more details on this Broker, you can read our review on Iq Option.
Compound interest: where to invest
To find a trading strategy that yields such high percentages we should copy what the best traders in the world do and one of the brokers we reviewed offers a free automatic trading system that copies the operations of these traders!
This tool is called Copy Trading and is patented by eToro, the operation is simple:
- Sign up for eToro
- Enter the “Copy People” section, filter the best traders based on their historical returns
- With one click you can copy the best ones, better choose at least 5 or 6 to diversify
At this point all their operations will be copied to your trading account, free of charge and automatically.Register on eToro and find out how much Top Traders, you could copy, earn
But how is compound interest applied to Copy Trading? Now we see it.
Compound Interest and Copy Trading: The Winning Method
In the “People” section of eToro there is a list of traders that can be selected based on their characteristics, below we see some of them:
To take advantage of compound interest, we must first filter the traders in this way:
- Time period: At least one year
- Profit: Greater than or equal to 20%
- Max Daily Drawdown: Less than 5%
At this point select a dozen Top traders, without haste, choose with patience and attention the ones you consider more regular.
Now let’s make an example to calculate the potential returns of Copy Trading combined with compound interest:
Let’s assume an investment of € 1,000 with an average weekly return of 5%, to keep this return constant you will need to check every week that the Top Traders chosen are generating regular profits, otherwise you will make “replacements”.
Every week you will always have to reinvest everything to increase the capital and in one year (52 weeks) you will get about 12,000 euros, or a + 1,200%
Obviously this is only a simulation but it gives a good idea of the potential of this Winning Method: Copy Trading + Compound interest.Find out the best traders on eToro: register for free!
We have explained the compound interest and we have given you some ideas to reflect on the potential of this mathematical tool combined with online trading, now do your simulations to find your “winning method”.
All the brokers we have reviewed allow you to do simulations on a Demo account, take advantage of these opportunities so as to practice compound interest without taking risks.
Here are the official links to access the Broker Demo accounts proposed in this guide:
- Access the eToro Demo account for free by clicking here
- Register for free on ForexTB from this link
- Register for free on Iq Option by clicking here
This is the interest on the interest, the capital is gradually made up of the accrued interest that increases the capital itself.
It is calculated by multiplying the principal by the interest rate plus 1, all the while increasing the number of periods.
It is used by constantly increasing the invested capital and maintaining a constant Trading strategy.
eToro is the most suitable broker for compound interest because it can be combined with automatic Copy Trading.