The gap between average return and compounded return caused by volatility, which quietly removes wealth without a single losing average.
Two accounts both average 10% a year. One returns exactly 10% every year; the other alternates plus 40% and minus 20%. After ten years the first has multiplied by 2.59; the second by (1.40 x 0.80)^5 = 1.12^5 = 1.76. Same average, 32% less money.
The size of the drain is roughly variance / 2. At 15% annual volatility that is about 1.1 percentage points a year; at 40% volatility it is 8 points; at 80% - normal for small-cap speculation or crypto - it is 32 points, which is why high-volatility strategies with genuinely positive average returns can still lose money over time.
Two implications for traders. Leverage multiplies the drain by the square of the leverage factor, which is the mathematical reason over-leveraged accounts bleed out even with an edge. And volatility reduction through sizing is not just risk control; it is a direct addition to compounded return.
Original diagrams for the ideas on this page. Illustrative, not real market data.
Margin and leverage. A $5,000 deposit can control a $100,000 position, which is 20:1 leverage. Because the loss is measured on the full $100,000, a 2.5% move against you halves the deposit and brings a margin call, and a 5% move uses all of it.
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