What is Pyramid Trading

How Does Pyramid Trading Work

To implement the pyramid trading strategy, you have to buy more shares as the stock price rises during a bullish phase. This approach helps you build a larger position, potentially leading to higher returns.

Let us take an example to understand how it works.

Suppose you initially buy 100 shares of XYZ Corporation at Rs 60 each, expecting the price to rise. The price does increase and reaches Rs 70 per share. Seeing this, you decide to buy an additional 80 shares at Rs 70 each.

The stock price keeps climbing and reaches Rs 80 per share. You then purchase 50 more shares at Rs 80 each. Now, you hold a total of 230 shares of XYZ Corporation, with an average purchase price of Rs 67.83 per share, approximately.

When the price reaches Rs 90, you decide to sell all 230 shares. Your total selling price will be:

230 shares x Rs 90 = Rs 20,700

Your profit will be:

Purchase Price: 230 shares x Rs 67.83 = Rs 15,600

Selling Price: Rs 20,700

Profit: Rs 20,700 - Rs 15,600 = Rs 5,100

Without using the pyramid trading strategy, you might have bought 100 shares at Rs 60 each and sold them at Rs 90. Your profit would be:

Selling Price: 100 shares x Rs 90 = Rs 9,000

Purchase Price: 100 shares x Rs 60 = Rs 6,000

Profit: Rs 9,000 - Rs 6,000 = Rs 3,000

By using the pyramid trading strategy, you earned an additional profit of Rs 2,100 (Rs 5,100 - Rs 3,000).

Different Types of Pyramid Trading

Here are some popular types of pyramid trading:

• Standard Pyramid

Also known as the upright pyramid, this method starts with a large initial position and smaller positions subsequently. Suppose you begin with 100 shares; the next position could be 80 shares, followed by 50 shares.

• Inverted Pyramid

In this approach, the size of all your positions is the same. For instance, if your first position is 100 shares, you continue adding 100 shares for each new position. This method is riskier because even a small price reversal can wipe out your gains.

• Reflecting Pyramid

It involves adding to your positions up to a set level. Once you reach this level, you start reducing your position by taking profits, even if the trend continues in your favour. The reflecting pyramid is less aggressive and usually yields lesser returns compared to other types.

• Maximum-Leverage Pyramid

This is the most aggressive pyramid trading technique. Here, you increase your positions with the maximum size allowed by margin requirements and accumulated profits. It offers the highest potential rewards but also comes with significant risk.

Advantages of Pyramid Trading

Pyramid trading offers several benefits, which are as follows:

• Reduces Early Withdrawals 

Pyramid trading helps traders avoid selling too early when a stock shows small signs of reversing. It encourages them to assess if the change is a real trend shift or just a temporary pause, allowing for careful consideration and the chance to make more trades in one go.

• Compounding Effect

With pyramiding, traders target stocks that keep growing. This method boosts the compounding of profits over time compared to the initial investment, creating a balance between potential gains and losses.

▶️ Also read, How Power of Compounding Works in Stock Market

• Lowers Risk

Pyramiding is favoured by conservative investors. It involves slowly increasing the investments while keeping a close eye on the market. This careful approach helps investors stay calm, reassess their positions, and reduce the risk of big losses.

• Flexibility

Pyramiding allows traders to adjust their positions in response to market conditions and price changes. Traders can increase or decrease their holdings as needed, staying flexible and responsive to shifting market dynamics.

Disadvantages of Pyramid Trading

The following are the limitations of pyramiding trading:

• Requires Sustained Upward Movement

For pyramiding to be effective, the stock price needs to move continuously in an upward direction for a certain period.

• High Capital Requirements

Investors may need a significant amount of capital to execute this strategy successfully.

• Risk of Significant Losses

If the stock price reverses earlier than anticipated, the strategy could lead to substantial losses.

The Bottomline

Pyramiding trading can be appealing because it helps you maximise your profit during a bullish market. While it can boost returns, it also increases the risk of losses if the market turns against you.

Therefore, as an investor, it is important to weigh both the advantages and disadvantages of pyramid trading before deciding on using this strategy.