Run two sequences. The first returns 10%, then 10%, then 10%. The second returns 40%, then minus 20%, then 10%. Their arithmetic averages are the same, 10% per period. After three periods the first account is up 33.1% and the second is up 23.2%. Nothing was mismanaged in the second one. The loss simply cost more than the arithmetic suggests, because it was applied to a larger base and the recovery was applied to a smaller one.
That gap is called volatility drag, and it is the mechanism behind almost every argument for consistency in trading. Not a moral argument about discipline. An arithmetic one about what a multiplicative sequence does to variance.
Why returns multiply instead of adding
An account does not carry percentages, it carries money. A 10% gain on 10,000 gives 11,000, and the next 10% is computed on the new figure. Over a sequence, the terminal value is the product of the period factors, not the sum of the percentages. Anyone sizing by fixed fractional risk is already compounding by construction, because the risk amount tracks equity up and down.
The consequence is that the order of returns does not matter to the final figure, but their dispersion does. Two sequences with the same average will diverge if one is more volatile, and the more volatile one always ends lower. This is not an opinion about which strategy is better. It falls out of the algebra: the geometric mean of a set of numbers is at most their arithmetic mean, and the gap widens with variance.
The recovery table, which everyone should memorise
The asymmetry between losses and the gains needed to undo them is where compounding stops being an abstraction.
| Drawdown | Gain required to recover |
|---|---|
| 10% | 11.1% |
| 20% | 25% |
| 33% | 50% |
| 50% | 100% |
| 75% | 300% |
| 90% | 900% |
Below about 20% the numbers are close enough that recovery feels ordinary. Past 30% the curve turns and each further loss demands a disproportionate gain. A trader down 50% has to double, and doubling is not a thing that happens on demand. This is the practical case for a hard drawdown limit that ends the month rather than a hope that the next trade works.
Withdrawals break the curve, and that is often correct
Compounding assumes profits stay in the account. Most traders withdraw, and every withdrawal permanently removes the future growth that money would have produced. Taking 2,000 out of a 10,000 account is not a 2,000 cost, it is 2,000 plus everything those 2,000 would have compounded into.
That is an argument for delaying withdrawals, not for never making them. An account that pays nothing out is an account whose owner has no reason to keep going, and traders who never realise anything tend to over-risk in search of a number that finally justifies stopping. A rule that fits the maths and the psychology is to withdraw a fixed percentage of profits above a threshold, so the base still grows while something comes out.
Funded traders face a version of this decision that is not theirs to make. Payout schedules are set by the firm, the base does not compound in the trader's hands, and growth comes from scaling plans instead. Understanding how the payout rules work matters more there than any compounding calculation.
Compounding cuts both ways. Losses compound with exactly the same mechanism as gains, and a strategy that produces a bad tail will destroy a base faster than a good average return rebuilds it. Leveraged trading carries a high risk of loss.
What consistency is worth in practice
The rate that matters is the geometric one, so the practical levers are the ones that cut dispersion rather than raise the average. Capping risk per trade. Refusing to double the size after a losing week. Removing the two or three trade types that generate the outsized losses even when they occasionally win. Every one of those lowers the arithmetic mean slightly and can still raise the compounded result.
It also explains why small consistent returns look unimpressive month by month and unrecognisable after two years. A steady 3% monthly compounds to roughly 42.6% a year. The same trader chasing 8% months and taking a 15% loss every third month ends up behind while feeling far busier. Neither figure is a promise about what any account will do, and past sequences say nothing about future ones.
There is a second reason consistency pays that has nothing to do with arithmetic. A trader whose monthly results sit in a narrow band can plan: they know roughly what a bad month looks like, they can set a withdrawal rule and keep it, and they are not making sizing decisions under the pressure of an unusual result. A trader whose months swing between plus 20 and minus 15 is repeatedly forced into judgement calls at exactly the moments when judgement is worst. The smooth curve is easier to trade, and being easier to trade is itself an edge.
Position sizing has to keep up
Compounding only happens if size grows with equity. A trader who runs a fixed 0.5 lot regardless of balance gets linear growth from a strategy capable of geometric growth. The percentage-of-equity approach handles this automatically, which is its main advantage over fixed lots.
Do it in steps rather than continuously. Recalculating size after every trade produces rounding noise on small accounts and creates the temptation to re-size upward mid-streak. Setting the sizing base once a week, or on a fixed equity increment, keeps the compounding intact and takes the decision out of the moment. Write the rule into the trading plan, where it can be broken visibly rather than quietly.
"Two traders, same average monthly return, completely different accounts after a year. The difference was that one of them never had a month that needed undoing."
— Alex Onta, Executive Director, SINGUARD
Key Takeaways
- Returns multiply rather than add, so a sequence with more dispersion ends lower than a smoother one with the same average.
- Recovery is asymmetric: 20% down needs 25% back, 50% down needs 100%, and the curve turns sharply past a third.
- Every withdrawal removes the future growth of that money, so withdraw a percentage of profits rather than fixed lumps that shrink the base.
- Compounding only works if position size tracks equity, updated in steps rather than after every trade.
Frequently Asked Questions
Why does a 50% loss need a 100% gain to recover?
Because the gain is calculated on the reduced balance. Half of 10,000 is 5,000, and turning 5,000 back into 10,000 is a doubling, which is a 100% return.
What is volatility drag?
The gap between the average of a set of returns and the growth they actually compound to. More variation in the returns means a lower compounded result for the same average.
Should I withdraw profits or leave them to compound?
Leaving them in grows the base faster, but never realising anything tends to push traders into oversizing. Withdrawing a fixed share of profits above a threshold satisfies both sides.
About the Author
Alex Onta is an Executive Director at SINGUARD. He built eTrader, the terminal, the mobile apps, eTrader Broker, Copytrading, Business and Community, along with the worldwide clustered-server infrastructure it all runs on, with his brother Roman Onta helping on the design, and he leads that division today. Together with Roman he builds the Prop Firm CRM, the Broker CRM, Scalegram and CopySignals, and the two of them carry worldwide compliance, payment processing and international business structuring side by side. He lives and works in Dubai for most of the year. Meet the executive duo leading Singuard's five divisions.