PYRAMIDING

Pyramiding is also widely mistaken as a money management method;however, like cost averaging, it is directly related to the performance ofthe particular market being traded. Pyramiding is the exact oppositeof cost averaging. Pyramiding is simply adding to a winning position.If Joe Trader invested $5,000 in a mutual fund at $17.00 per share,then Joe would invest another $5,000 if the mutual fund went up to$18.00 (or at whatever price Joe decided to invest more as long as theprice was greater than $17.00).The logic behind pyramiding is that if a particular trade is movingin the preferred direction, then the market is probably trending andadditional investments are made with the hope that the market willcontinue in the direction of the current trend. It can be very powerful.However, it can also be disappointing if the market doesn’t continue tomove in the desired direction. The following illustration captures thecharacteristics of pyramiding.Joe Trader has bought an orange juice contract at 80 cents andplans to buy another contract at every 5 cents the market moves up.Therefore, if the market goes to 85 cents, Joe will buy another contract,and another if the market goes to 90 cents, and another at 95cents, $1.00, and so on.Pyramiding$1.05 current price - S.925 average purchase price=$.I25 profit per contract$.125 x 6 contracts = $.75 total profit. $.75 x 15,000 =$11,250Not pyramiding$1.05 current price - $.80 purchase price = $.25 profit$.25 x 15,000 = $3,750 total profitTo protect $3,750 in profits with pyramiding$3,750 profit / 6 contracts = $625 per contract$625 profit per contract I 15,000 pounds = $.0416$.925 average purchase price + $.045 (rounded up) =$.97 (or $625 per contract)28 TYPES OF MONEY MANAGEMENTWhat happens if after Joe buys at 80 cents, the market movesup to 85 cents and Joe buys another contract; but then the marketmoves back down to 80 cents? Instead of breakeven, Joe will havelosses of 272 cents per contract ($750 loss = 2Y2 cent loss X 2 contractsx 15,000 lbs.). If the market moves to 90 cents and Joe buys athird contract, the losses will be 5 cents per contract ($2,250 loss).However, if the market continues to move higher to $1.05, Joewill have bought a total of 6 contracts at an average price of 92.5cents [(.80 + .85 + .90 + .95 + 1.00 + 1.05) / 61 = 92.5 cents. The totalopen position profit on the trade is at $11,250. Had Joe not used thepyramiding method, the profit on the trade would only be at $3,750.Further, Joe can let the market move down to 97 cents and stillmake $3,750 on the trade with the pyramiding method.This illustration neither promotes nor discourages pyramiding.There are obvious risks to be considered for the extra potential reward.Most of the risk comes on the front end of the method, whilemost of the reward comes in on the back end. The key is to make it tothe back end.Finally, the decision to pyramid is completely separate from thetotal performance of the account. For example, if an account startedwith $20,000 and because of a series of losing trades is down to$17,000, the ability to pyramid the orange juice market is based onwhether that market moves up regardless of whether the account as awhole is in the red. This is another reason that it must not be confusedwith money management. In pyramiding, the trader decideswhether to get in based on market action.