Every trading strategy consists of buying and selling so how should we know if one of them is more superior? The name compound trading honestly sounds “clickbaity” however it is accurate to a large extent. This strategy is employed to identify exit and entry points for execution to maximize the opportunity cost of each tranche of capital deployed in the market. The term compound is used because this strategy will recommend transferring capital returns (ex-Comms) from your last exit to the next entry to compound subsequent gains from the next profitable exit. In simpler terms, you are trying to minimize time wasted while waiting for stocks to consolidate and let your capital ride on the next potential bounce for maximum returns in the short term. After using this technique for many years, I strongly recommend investors try this technique out. In today’s post, I will be sharing more about this technique as well as its pros and cons.

How to execute compound trading

To execute this strategy, you need to fully embrace the buy low sell the high idea in an extremely reflexive manner. Basically, you have to route capital to the best position where it can climb just enough to make a slightly significant return (1.3 to 4%) before transferring it to the next stock. This will allow you to compound your gains along with your capital continuously rather than waiting during consolidation or volatility. Using a compound interest calculator, a 10k investment with an average of 1.5% returns per trade will yield a total of $12,502.32 or 25% if you manage to hop 15 times in a year. Such returns are likely to surpass the average yield of most indexes.

Benefits of using compound trading strategy

Using the compound trading strategy, traders will be able to minimize losses due to opportunities costs. For example, if a stock consolidates for a period of 2 months, then it also means that the capital deployed is dormant for the duration of 2 months. Instead, if you transfer the same sum of capital to other stocks with the potential for faster returns in the meantime, then it will definitely help push your yields higher compared to leaving it in a more or less “dormant” state. With practice, users of this strategy will become more opportunistic with a portion of his or her funds, as they will learn how to detect opportunity as well as avoiding overly long periods of consolidation.

Shortfalls of the compound trading strategy

Throughout our trading careers, we will all land into at least a few falling knife situations. Hence if you increase the frequency of trading, you will also increase the odds of landing into a falling knife situation. At that point, you will feel regret and disappointment like everyone else. However, if you plan ahead for such situations, you can always sacrifice a small portion of your capital and exit before making further losses if you are confident about the stock’s trajectory. Besides that, you are also at risk of missing out on further upside because sometimes exiting at a point after a significant jump might be followed by a long-term rally.

Closing thoughts

There is still no such thing as a perfect trading strategy. If possible, I would recommend that we should execute multiple strategies at once so that we can mitigate the negative impacts of each strategy. For example, if you are confident about a company’s future but are also aware that the good news is still far from fruition, you can always choose to exit the moment you have spotted better opportunities for your capital to gain upside. At the end of the day, the compound trading strategy is just about making use of a few tranches of capital to maximize short-term gains in hope of yielding a significant return over time.