About the magic of compounding

Magic of compoundingQ: Magic of compounding sounds too good to be true. So, is it true?

A: It is a mathematical model that permits you to compare alternatives.

Q: It is not realistic. People do not get these types of returns. Reality is different.

A: Yes, most people are negative and do not even try. Then there is the issue of mental and emotional strength to even permit an attempt. Let me give you another alternative. The futures market is the most efficient venue for pyramiding so let’s run the numbers on that. You start with $100,000 and the price of gold increases in a nice orderly way; you get no margin calls and you increase your positions by twenty percent for every one percent increase in the price of gold. That means you compound a twenty percent profit sixty-one times. The resulting profit is $6.76b.

There are a number of limiting factors, which, as you point out, make it unrealistic to assume you could actually achieve such a result. The exchanges have position limits. You would not be permitted to open that many positions. It is highly likely that you would get margin calls. Markets are not always orderly. Execution of orders may not be filled at all or be filled at prices outside the model. I have not offered to do your trading nor have I made a projection of what will happen to the price of gold, gold shares, or options on gold shares. The purpose of this exercise is to evaluate the use of leverage and compounding under a given set of assumptions. The assumptions are all clearly stated in the presentation.

Q: Yes, you have stated the assumptions. I am having a hard time believing the numbers. Where is the error?

A: It is not in the math. That means the logic is not in error. Math is just a system of logic. So the conclusions are valid. If the premises are true then the conclusions are also true. The only way to refute this is to show that one or more of the premises or assumptions are not true. You might have a good point. Take your best shot.

Q: Perhaps I have come to the battle of wits unarmed. I need more education. Can you help me?

A: Yes. Read Murray Rothbard’s Man, Economy, and State and Ludwig von Mises’ Human Action.

Q: Can you also recommend some current writers?

A: Yes: David Stockman (David Stockman’s Contra Corner), Paul Craig Roberts (Institute for Political Economy), Gerald Celente (Trends Research Institute) and Martin Armstrong (Armstrong Economics). But first, you need the foundation in understanding economic law you can get from Rothbard and Mises. And, it would not hurt if you read my book, The Art of Speculation during Civil War – Sun Tzu Meets Jesse Livermore.

Q: You have assigned me a lot of work.

A: If it were easy, everyone would be a billionaire, and being a billionaire would be meaningless. Just to be clear, the above assignment only addresses the mental understanding issue. In addition, a successful trader must have the right emotions and take the right actions to do what needs to be done and to do it in a timely manner. That presents a set of challenges in addition to what has been discussed so far.


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