Compounding or Fixed Risk: Two Paths From the Same Trades

[Shadow Trader]

Two accounts can take the identical sequence of trades and finish in very different places, depending only on how risk is sized. Fixed risk keeps every trade at the same currency amount, so results add up. Compounding risk keeps every trade at the same percentage of current equity, so results multiply.

The difference is path dependence. With percentage risk, an early losing run shrinks the base, and later wins are worth less in currency terms. The same wins arriving first would have enlarged the base and made later losses hurt more in currency terms. Order matters under compounding, while under fixed risk the final total ignores order entirely.

This has a practical side effect. Compounding makes the equity curve convex in good stretches and punishing in bad ones, so the experience of a drawdown feels different from the arithmetic average. Fixed risk produces a steadier, more linear record, which is easier to evaluate but grows more slowly when an edge exists.

A middle route is stepped sizing, where risk in currency terms is reset only after equity has moved by a set band, for example monthly or after a defined gain. That keeps some growth effect while limiting how quickly a short streak changes position size. Whichever method is chosen, the rule belongs in writing before trading starts, because changing the method mid-streak is a form of discretion that quietly alters results.