Pyramiding Open Positions
Pyramiding is the practice of adding to an existing winning position. It differs from scaling in to a position – scaling in is a way of building a planned position, whereas pyramiding is adding to a planned position.
Let’s start with what pyramiding is not – it is not adding to a losing position. The ‘logic’ behind this action is that if you buy additional stocks at a lower price, you reduce your average cost per unit. However, it makes no sense to invest in losers – remember, let your profits run but cut your losses. Adding to losers isn’t pyramiding; it’s digging a hole!
Pyramiding is adding to winning positions. It should be a planned part of your system, with a fixed trigger point, e.g. buy more if the stock rises 10%. It’s also important to have clear and fixed plan for how many units you will buy. Let’s work on an example, in which you buy an equal amount each time:
Initial purchase 100 units @ 10.00 1,000
1st pyramid 100 units @ 11.00 1,100
2nd pyramid 100 units @ 12.00 1,200
Can you see a problem here? This is not a pyramid, because a pyramid is bigger at the base, and reduces in size as it grows upwards. If the price should turn down, your largest position is the first one to move into a loss, and these losses could wipe out the profits you earned further down the pyramid.
An improvement would be to invest the same dollar amount, like this:
Initial purchase 100 units @ 10.00 1,000
1st pyramid 91 units @ 11.00 1,001
2nd pyramid 83 units @ 12.00 996
It's still not really pyramiding is it? This is a tower block! The correct way should be to reduce the dollar amount invested by some formula – so, for instance, you could do it in the ratio 4:3:2, as follows:
Initial purchase 100 units @ 10.00 1,000
1st pyramid 68 units @ 11.00 748
2nd pyramid 41 units @ 12.00 492
Then, if the price were to turn against you, the smallest part of the pyramid would move into loss first, hopefully allowing you to retain your earlier profits.
Copyright © 2011 Mick Brooks