What is Pyramiding in Trading ?

 

So guys, welcome to VRD nation. If you are new to the world of stock market, if you are new to the world of investing and training, you should definitely go ahead and subscribe to this channel because you cannot afford to miss the kind of experience, the kind of learning that we share on this channel.

Now, before we get started, I just want to say one thing that in order to understand this topic, you need to have an understanding of what Position sizing is. If you already know about position sizing, then you can easily understand this topic, but if you don’t, then I would strongly recommend you to watch this video that we have made specifically on position sizing that will give you the right background that you need to understand this video.

The topic at hand is that of Pyramiding.I will explain that using a real life example from today’s trade itself and I hope that you guys will enjoy this video. So what is pyramiding? Pyramiding is a position sizing technique where you add more capital to trades only if they turn profitable.

For example, you bought a stock at a hundred rupees with 2 Lakhs rupees of capital, and now the trade started working for you. The stock moves up from 100 rupees to 10 per share and so now we are making a profit of 10%. Hence pyramiding would mean adding more money to this already profitable trade.

If you decide to add another two Lakhs rupees to this trade, you will be pyramiding your position. Now, some of you might be wondering then what is the relevance of this word Pyramiding in this case? Well, there is no official definition of Pyramiding as such, but normally if you look at a Pyramid, how does it appear?

The base is the biggest and then as you go towards the top, it becomes more narrow. In the same way, when a trader is doing Pyramiding, they normally enter at half of their position size. Then as the trade starts working, they add more and more and every time they add to the position, the position size normally becomes smaller.

The size of the position then basically looks like a Pyramid, but here is something that I have seen from my practical experience that Pyramiding is a little counterintuitive to a lot of traders, and that is why very few traders actually do it.

Let me explain why. So let’s go back to the same example that we took earlier where the initial buying price was 100 rupees. Now, after this stock went from 100 rupees to 110 a share, let’s say you promote your position. What do you think will be averaged by, in present? Well, it will be somewhere around 105 rupees.

When most of the traders look at this situation when their average buying price is going up, they think they were sitting on a 10% profit, but after promoting, my profits have certainly gone down to just 5% and that is the first thing that they start getting worried about. Secondly, they get worried that if the stock goes down, they are much more likely to lose all the profits that they have made earlier.

It is because, earlier they had a much bigger buffer of 10%, but now their buffer has gone down to only 5%. Hence it is very difficult for somebody who is already in profit to see their position getting into a loss. That is the reason why Pyramiding is not very popular. In fact, most of us use an exactly opposite position sizing technique called Averaging which involves adding to their losing position.

Now we have made a separate video on average, and you can just check it out when you get some time. Every professional trader that I know, and have worked with, likes to do Pyramiding and there is a very important reason for that.

The first thing that you have to understand here is that when you use the approach of Pyramiding, you are only entering with X amount of quantity and are waiting for the market to give you a confirmation before you add more to that position. Assume the trade did not work out and you incurred a loss. Now this loss that you will be incurring on this trade will be on a much smaller position size as compared to a situation if you would have entered with the whole quantity, all in one shot. In absolute terms, the loss will be smaller using this approach.

Secondly, I think a more fundamental reason for doing Pyramiding is that when a trade is profitable, we already know that the trade is working out.

Hence I don’t need to take a leap of faith and need to just sit and hope for the stock to turn around for me to become profitable since I already have the proof that I need, whereas a losing trade is all about praying.

So today is a perfect example of how Pyramiding works in their life. When the day started, I had a view that the market was going to come down, whereas what happened was instead of coming down, the market had its own wisdom and started to go up and in fact started going up very aggressively against me. As you can see here, I was at a loss and at this time I had to make a choice. Should I stick to my view that the market is going to come down or should I follow the market and just add more to a position which was already working. Naturally, I did the latter and I added to the position, which was making me a profit.

Actually I did it two times and you can see that this is the basic idea behind Pyramiding. You have a trade, which is working out, you add more capital to it and if there is a trade, which is not making money, you do not add anything to that position.

Now this day has several other learning and one of them is about Mean reversion, which I will talk about in a different video. The point that I’m trying to make here is that professional traders always respect the market’s view and until they get a clear confirmation or a clear signal from the market, they do not add more to their position.

Hence that was a real life example of how professional traders use Pyramiding in their day to day trading. In fact, the concept of Pyramiding is not just applicable in trading. It is equally applicable in investing as well.

I hope that you understand it well and know how this thing works into your life, but like anything in life, there are always pros and cons to what you do. Hence, you always have to use your judgment, instinct and follow a process to decide whether you want to add more to a position or not.

So guys, welcome to VRD nation. If you are new to the world of stock market, if you are new to the world of investing and training, you should definitely go ahead and subscribe to this channel because you cannot afford to miss the kind of experience, the kind of learning that we share on this channel.

Now, before we get started, I just want to say one thing that in order to understand this topic, you need to have an understanding of what Position sizing is. If you already know about position sizing, then you can easily understand this topic, but if you don’t, then I would strongly recommend you to watch this video that we have made specifically on position sizing that will give you the right background that you need to understand this video.

The topic at hand is that of Pyramiding.I will explain that using a real life example from today’s trade itself and I hope that you guys will enjoy this video. So what is pyramiding? Pyramiding is a position sizing technique where you add more capital to trades only if they turn profitable.

For example, you bought a stock at a hundred rupees with 2 Lakhs rupees of capital, and now the trade started working for you. The stock moves up from 100 rupees to 10 per share and so now we are making a profit of 10%. Hence pyramiding would mean adding more money to this already profitable trade.

If you decide to add another two Lakhs rupees to this trade, you will be pyramiding your position. Now, some of you might be wondering then what is the relevance of this word Pyramiding in this case? Well, there is no official definition of Pyramiding as such, but normally if you look at a Pyramid, how does it appear?

The base is the biggest and then as you go towards the top, it becomes more narrow. In the same way, when a trader is doing Pyramiding, they normally enter at half of their position size. Then as the trade starts working, they add more and more and every time they add to the position, the position size normally becomes smaller.

The size of the position then basically looks like a Pyramid, but here is something that I have seen from my practical experience that Pyramiding is a little counterintuitive to a lot of traders, and that is why very few traders actually do it.

Let me explain why. So let’s go back to the same example that we took earlier where the initial buying price was 100 rupees. Now, after this stock went from 100 rupees to 110 a share, let’s say you promote your position. What do you think will be averaged by, in present? Well, it will be somewhere around 105 rupees.

When most of the traders look at this situation when their average buying price is going up, they think they were sitting on a 10% profit, but after promoting, my profits have certainly gone down to just 5% and that is the first thing that they start getting worried about. Secondly, they get worried that if the stock goes down, they are much more likely to lose all the profits that they have made earlier.

It is because, earlier they had a much bigger buffer of 10%, but now their buffer has gone down to only 5%. Hence it is very difficult for somebody who is already in profit to see their position getting into a loss. That is the reason why Pyramiding is not very popular. In fact, most of us use an exactly opposite position sizing technique called Averaging which involves adding to their losing position.

Now we have made a separate video on average, and you can just check it out when you get some time. Every professional trader that I know, and have worked with, likes to do Pyramiding and there is a very important reason for that.

The first thing that you have to understand here is that when you use the approach of Pyramiding, you are only entering with X amount of quantity and are waiting for the market to give you a confirmation before you add more to that position. Assume the trade did not work out and you incurred a loss. Now this loss that you will be incurring on this trade will be on a much smaller position size as compared to a situation if you would have entered with the whole quantity, all in one shot. In absolute terms, the loss will be smaller using this approach.

Secondly, I think a more fundamental reason for doing Pyramiding is that when a trade is profitable, we already know that the trade is working out.

Hence I don’t need to take a leap of faith and need to just sit and hope for the stock to turn around for me to become profitable since I already have the proof that I need, whereas a losing trade is all about praying.

So today is a perfect example of how Pyramiding works in their life. When the day started, I had a view that the market was going to come down, whereas what happened was instead of coming down, the market had its own wisdom and started to go up and in fact started going up very aggressively against me. As you can see here, I was at a loss and at this time I had to make a choice. Should I stick to my view that the market is going to come down or should I follow the market and just add more to a position which was already working. Naturally, I did the latter and I added to the position, which was making me a profit.

Actually I did it two times and you can see that this is the basic idea behind Pyramiding. You have a trade, which is working out, you add more capital to it and if there is a trade, which is not making money, you do not add anything to that position.

Now this day has several other learning and one of them is about Mean reversion, which I will talk about in a different video. The point that I’m trying to make here is that professional traders always respect the market’s view and until they get a clear confirmation or a clear signal from the market, they do not add more to their position.

Hence that was a real life example of how professional traders use Pyramiding in their day to day trading. In fact, the concept of Pyramiding is not just applicable in trading. It is equally applicable in investing as well.

I hope that you understand it well and know how this thing works into your life, but like anything in life, there are always pros and cons to what you do. Hence, you always have to use your judgment, instinct and follow a process to decide whether you want to add more to a position or not.