Pyramiding is one of the trading methods of increasing capital. The essence of this method consists in the sequential opening of several transactions with a favorable trend. First of all, it is necessary to note the fact that pyramiding is not a trading strategy, like scalping, but is only a method in trading management. One of the main features of this method is minimum risks with high income indicators.
The strategy of pyramiding is very similar to the common method of playing roulette, when at an unfavorable outcome, the next bet exceeds the previous rate by 2 times. In trading this method is called martingale. Unlike martingale, in the case of pyramiding, the next trade is opened in the case of a negative outcome rather than a negative one. Thus, the risks apply only to the winning amount and the minimum initial bet. The amount of the win depends on the number of stages of the pyramid and increases exponentially.
How it works
In order to understand how this principle works, we have prepared an illustrative example for the EUR/USD currency pair. The picture 1 below shows a downtrend channel. Since the bears are in control, we want to take an advantage out of the short side. The stop loss will be activated if the price leaves the channel. In this case, a transaction with a volume of 0.1 lot is opened at 1.2200. Stop-loss will be at the level of 1.2240, and in this case the risk will amount to $40. With standard trading plan, if the trade is closed at 1.1900, the trader’s profit will amount to $300.
However, in pyramid trading, the following plan is used.
- The transaction opens at the level of 1.2200 with a lot volume of 0.1. Stop-loss is at 1.2240.
- The price reaches the level of 1.2140, the profit is $60. We trail stop loss, and a new order with a volume of 0.2 opens. Thus, the total volume is 0.3 of a lot.
- The price reaches the level of 1.2000, the profit is $480. We trail stop loss, and a new order with a volume of 0.4 opens. The total volume is 0.7 of a lot.
- The price reaches the level of 1.1940, the profit is $900. We trail stop loss, and a new order with a volume of 0.8 opens. The total volume is 1.5 lot.
- The price leaves the channel at 1.1900 and activates our trailing stop losses. The total profit is $2,060, while throughout the trade the amount of risk never exceeded $40.
This example clearly shows the possibilities of pyramiding. In the examined case, the profit was increased by more than 50 times compared to the standard trade. In the above example, an aggressive and risky pyramid model was used, because the risk of losing $40 existed until the closing of the trade. In order to protect yourself against losing the initial trade money, for this case, you can use a less risky option.
This variant of pyramiding differs from the first only in that at each level of the pyramid, instead of adding an order with an increase of 2 time of the volume of the bid, an order with a volume of 0.1 lots was added. Thus, at the second step, in case of unfavorable developments, the trade will close with a zero. And on the fourth step, when the trend is reversed, the trailing stop is activated on a 1.1900 with a guaranteed profit of $680.
Advantages and disadvantages
The advantages of using pyramiding are obvious: an increase of profit in several times compared to a standard trade and minimizing the risks, or even their absence. However, as it is the case with all trade managements, more difficulties arise when you implement this method. Among the shortcomings of pyramiding are the following:
- The difficulty in managing a large number of open transactions;
- Ability to use only on higher and medium time intervals;
- The presence of a favorable trend for a long time;
Pyramiding is a trade management system for more experienced traders. Beginners are not advised to use it, since it is necessary not only to correctly calculate the opening interval of orders, but also to predict the reversal point and close the trade on time. It is especially important to determine the end point of pyramiding, because if you hurry with closing, you can lose a significant part of the profit. This method is not suitable for fans of quick earnings. And if you prefer the scalping technique, knowing the basics of pyramiding will not be useful to you.
Well, the most important factor of successful pyramiding is the presence of a favorable trend (Picture 2). But precisely in this regard the greatest difficulties arise. In the picture 1 above, the trend rose strictly downward, without corrections, which would lead to the immediate closure of the trade. But in practice, such a lucky coincidence happens not so often and as a rule the pyramid closes on the second — the fourth stage. And not always in favor of a trader.
And in the end, one more rule of using pyramiding is a strict limitation of the number of open orders (especially with regard to the aggressive method of trading). A trader must calculate the limit on the number of steps of the pyramid at the opening of a trade. Even with a very favorable trend, you cannot be tempted to open another last order, and then another last and the last one.