Pyramid Trading can be part of your money management and trading system allowing you to take advantage of trends that can persist for longer than you anticipated or beyond the scope of your normal trade holding periods. You want to take advantage of a sustained move in the financial instrument that you are trading.
Many traders experience these trends at various points in their career. You are expecting a certain market movement, to a certain level, but instead of the market stopping at that key level, it decides to blow through it and continue trending. Or the market just continues moving in a certain direction defying all the normal retracements that usually come. You count the days that the market keeps posting a fresh high or low and the days just keep on tallying up. Or perhaps you feel more strongly about a certain trade that has just broken out and you would like to add to your existing position.
You could have a short position on. You got in at a good price. The market breaks through critical lows. You analyze the market again and think that the move stands a good chance to go lower and you want to add to your existing position – aka you want to pyramid your position.
Done correctly it can exponentially increase profits during strong market moves. Done incorrectly and you can blow your account in short order.
Most traders DO NOT pyramid properly. Lets say you have a $25,000 account and decide to place a trade with 2% risk and a 50 pip stop loss on the EUR/USD. That would be a position size of 100,000 units or 1 standard contract. The market moves in your favor and you decide you want to start pyramiding – you want to start adding more short positions. Now what most traders do is when they go to add another short position they add in another 1 standard contract. Bringing up their total position size to 2 standard contracts. Then when the market drops more and they go to pyramid again, the add another 2 standard contract short position. Pretty soon they started with a position size of 1 standard contract using 4:1 leverage, and they have ended up with a position size of 4 standard contracts using 16:1 leverage. That is NOT smart trading. That is dangerous as you are getting in most of your position size at progressively worse prices. Sure you may have a decent paper profit on your initial positions, but that is still not enough to justify dialing up the leverage from 4:1 to 16:1 leverage. That is how the amateurs do it. The pros do it a lot differently.
What the pros do is as the position moves in their favor and they choose to start pyramiding – they add position size that is smaller than their initial position size.
Let us flip the pyramiding situation to taking advantage of a strong upward trending market. The pro trader with a $25,000 account may start off with a long position of 1 standard contract. Then if the market moves in their favor, and they choose to start pyramiding they will start adding position size, but it is smaller than their initial position size of 1 standard contract. So for example they may choose to add a 50,000 position, or 5 mini lots(half a standard contract). Remember that their initial position was 100,000 units. When they started pyramiding they add another 50,000 position. This is small than their initial position size. This allows them to take advantage of a sustained move in the market, without piling on a massive amount of more risk and leverage. Yes assuming that the trade is correct, they will make less % return than the person trading crazy leverage, but there account will be FAR safer and be able to withstand draw downs much better. The pro trader knows that they do not need to bet the house on every trade as there will be great trades to take advantage of and pyramid in the future. Nice steady returns to compound the money in their accounts. The amateurs are trying to turn $25,000 into $10,000,000 within a few months are trying to bet the house on every trade because they are pyramiding inappropriately and are suffering large draw downs and blown accounts because of it.
If you really think about it, that is the only way to pyramid properly. That is the way the pros do it and survive for the long term to take advantage of market volatility and movements spread out over many years.
Let’s say a hedge fund has a $1 billion dollar position in the markets. Were they to follow the amateur style of pyramiding, they would be adding another $1 billion position size, then another $2 billion, then another $4 billion. That would be an insane risk to put their fund through, not to mention that their is enormous liquidity risk in their positions as well.
The real way the pros do it, is if you have a $1 billion dollar position and are very sure of the trade, you can add another $300 million position, then if you are really sure, you can add another $100 million here, another $100 million there. Notice they are always adding position size that is smaller than their initial position size.
That is the way the pros do it. Follow them and your account will grow much steadier and safer.
What the pros do is as the position moves in their favor and they choose to start pyramiding – they add position size that is smaller than their initial position size.
You may ask how often do I use pyramiding? Very sparingly. If you place 100 trades a year and start using pyramiding on every trade, you will probably be disappointed. Instead focus on using pyramiding on the very best 3-5 trades during the year that result in a big move and that pyramiding can actually work to juice your returns.
What is a good book you can read on money management and position sizing: Try Dr. Van Tharp’s Trade Your Way to Financial Freedom
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