What is Compounding in Trading?

“Compounding” occurs when returns generated on an investment “remain invested” and subsequently generate additional returns. Over multiple periods, returns can therefore accumulate on both the original capital + earlier returns. To ascertain the compounded maturity value of an investment, the following formula is generally used:

• A=P(1+r)n

Where:

• A = final value
• P = initial investment
• r = return per period
• n = number of periods

Now, if we talk about compounding in trading, it can potentially be realised only when profits are retained in the trading account and redeployed. For example, 

• ₹1,00,000 growing at a hypothetical 10% per year may become ₹1,10,000 after one year and ₹1,21,000 after two years, before taxes, costs, and other factors.

Note that the power of compounding in the stock market may potentially become more pronounced over longer periods because each period’s returns form part of the capital base for subsequent periods. 

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