Day traders and short-term traders tend to focus on multiple,relatively small gains, repeated over a period of time. The constant investment of a growing investment pool can have a significant impact on long-term returns, even on relatively small monthly returns. This is similar to the principle of interest on interest, a strategy used by credit card providers. So what do we mean?
Demonstrating the trading strategy
If we assume that short-term traders will target at a 10% gain and automatically sell up on a 10% stop-loss, this is a relatively simple strategy. The real benefit of this type of trading strategy is when profits are reinvested month after month. We will now take a look at two different scenarios that demonstrate the point.
For illustration purposes, we will assume that each strategy begins with a £1,000 investment fund, which is fully invested each month:-
A 10% return each month over a 12 month period
While it may be a challenge to regularly return a 10% increase in your investment pot, month after month, it is not out of the question. The following table illustrates the impact of compound returns:-
|
Month |
Capital |
Cumulative Return on Initial Capital |
|
0 |
£1000 |
|
|
1 |
£1100 |
10% |
|
2 |
£1210 |
21% |
|
3 |
£1331 |
33% |
|
4 |
£1464 |
46% |
|
5 |
£1611 |
61% |
|
6 |
£1772 |
77% |
|
7 |
£1949 |
95% |
|
8 |
£2144 |
114% |
|
9 |
£2358 |
136% |
|
10 |
£2594 |
159% |
|
11 |
£2853 |
185% |
|
12 |
£3138 |
214% |
If you put this into perspective, let’s assume that the trader still made a 10% return each month but rather than investing, withdrew the profits. At the end of the 12 month period, they would still have £1000 in investment capital and a further £1200 in profits put to one side. This equates to £2200 (a profit of 120%) in total against a compound figure of £3138 (a profit of 214%). By simply reinvesting profits each month, this has increased the annual return by £938 or 42.6%. That is the power of compound returns!
Same strategy with a 10% loss every four months
We will now take a look at the figures for a similar strategy,but with an additional key factor, every four months there is a 10% loss on capital. The following table illustrates the impact of compound returns in this scenario:-
|
Month |
Capital |
Cumulative Return on Initial Capital |
|
0 |
£1000 |
|
|
1 |
£1100 |
10% |
|
2 |
£1210 |
21% |
|
3 |
£1331 |
33% |
|
4 |
£1198 |
20% |
|
5 |
£1318 |
32% |
|
6 |
£1449 |
45% |
|
7 |
£1594 |
59% |
|
8 |
£1435 |
43% |
|
9 |
£1578 |
58% |
|
10 |
£1736 |
74% |
|
11 |
£1910 |
91% |
|
12 |
£1719 |
72% |
As you can see, by consistently registering a 10% loss every four months the annual return slipped from 214% down to 72%. In monetary terms, the annual gain is £719 compared to a £600 gain when consistently investing £1000 per month, increasing/deducting the profit pool each month. In monetary terms the advantage of the compound return is just £119 or 19.8% gain when profits are not reinvested. The reason for this is because when the investment pool falls by 10% every four months, this is based on a far higher figure than the nominal £1000 starting figure.
Everything is relative
Even a 72% annual gain, compared with a 214% annual gain, is still mighty impressive, although everything should be considered in relative terms. It is interesting to see the effect of compound returns significantly reduce annual return where there is a loss every four months. The difference in profits falls from an improvement of 42.6% to just 19.8%.
Competitive charges
Day traders tend to take relatively small profits frequently, often using a stop-loss strategy to limit the downside. Consequently, GIS UK Ltd has continued to invest in new technology so that we can remain competitive on charges while maintaining a cutting-edge dealing service. This is a long-term strategy which has proven beneficial for clients and the company.