The Pyramid trading is a technique that allows traders to minimize chances of loss while enhance their ability to profit from “expected” market price movement at the same time.
The Pyramid technique alone is not enough to build a profitable trading plan, a sound Money Management technique is also needed to help traders to control their risk and loss.
Many Traders throw their money away by buying more shares of a company that goes against their initial expectation. By ignoring stop and buying more when a stock is in downtrend, the average price may be lower but the amount of trading capital for the trade will be increased. Traders will ends up draining their trading equity if they follow this strategy that is called ‘Averaging Down’.
In contradiction with the ‘Averaging Down’ method, the pyramiding adds equity to a trade that is already trending in the expected direction. The average price may be higher but the amount of traders’ capital will be decreased because the pyramid tactic virtually trades using money made from the market rather than their own capital.
To formulate the trading plan using the pyramid trading system that incorporates a sound money management, let’s consider the following.
Assume that traders are trading a futures contract, starting by buying 1 contract @ 100. By applying money management technique, traders want to risk only 20% of their capital. Therefore the stop is 80.
Then the contract price moves up to 120 and the stop moves to break-even. The move to 120 is a pyramid signal to buy an additional contract @ 120 the stop for this contract is 100.
Now traders have 2 contracts, 1 bought @100 and 1 @ 120 both have their stop at 100.
The contract price rises to 140 and the trailing stop of the first position is moved to 120 and the break-even stop of the second position is also moved to 120. This signals traders to buy an additional contract again @ 140 and the stop for this contract is 120.
Now traders have 3 contracts, 1 bought @100, 1 @ 120 and 1 bought @ 140. All of them have their stop at 120.
At this point the risk is 0%. If the contract price falls below the stop, all position will be closed. Traders will gain 20 from the first position and 20 from the second position but lose 20 from the last position. This makes no profits and no loss for traders .
What will happen if the contract price rallies to 160; the trailing stop for the first of two contracts are will be moved to 140 and the break-even stop of the third contract will be 140. If traders follow the signal and buy a new contract @ 160
Traders will have 4 contracts 1 bought @100, 1 @ 120, 1 bought @ 140 and 1 bought @ 160. All of them have their stop at 140.
At this point, profits are guaranteed for traders even the contract price fall below 140.
Finally, please be noted that this example does not account for slippage, commissions, or other fees associated with trading.
Before using this technique, the paper trade is needed to develop the confidence and skills for successful trading.
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Article says: “Now traders have 3 contracts, 1 bought @100, 1 @ 120 and 1 bought @ 140. All of them have their stop at 120.
At this point the risk is 0%. If the contract price falls below the stop, all position will be closed. Traders will gain 20 from the first position and 20 from the second position but lose 20 from the last position. This makes 20 for traders as profit.”
This is wrong. With stop at 120, you’d have +20 profit on first, 0 zero profit on 2nd, and -20 loss on third. Gross profit is 0, not +20.
Thanks for correcting this.
Hi Barry,
Thanks for your comment and sorry for my wrongly posted.
I have not reviewed it as well as I should. The posted was edited as your comment.
By the way I’m very glad that readers give me feedback.