The term ‘pyramiding’ refers to the adding of positions to an existing holding as the share price moves in the direction of the current trend.
The key benefit of pyramiding is that a clean and sustainable trend will allow excessive gains to be made with minimal additional risk taken
Pyramiding does require a little extra work, extra commissions, a little extra frustration, extra risk, but over the longer term it should provide substantially bigger gains.
The most important element of correct pyramiding is to increase position exposure whilst at the same time keeping ‘manageable’ risks under control.
One unit of risk, known as 1R, is the distance between the entry price and the protective stop price
Let’s assume our system dictates that the entry is $1.10 and the protective stop is placed at $0.80. The risk is $0.30 ($1.10 - $0.80), therefore 1R = $0.30.
The first pyramid level is Entry + 1/2R
Therefore, $1.10 + $0.15 = $1.25
If we get filled on Pyramid #1 we then need to move the initial stop up so as to keep risk aligned as much as possible. The stop should be moved up from its initial position by 1/2R as well.
The next thing to note is that at each pyramid level we buy the same amount of shares as the initial allocation. If you feel the extra risk is not for you, then buy a smaller parcel. It’s more important that the stop is kept away from the current action rather than tightened up to lower risk. In order to lower risk, buy fewer shares instead.
It’s important not to keep pyramiding. The trend has, in theory, a finite length. The more you add to positions the higher the chances of pyramiding into the end of the trend or creating such a large position the exposure becomes extreme.