What is Pyramid Trading?

Last Updated on September 27, 2023 by BFSLTeam BFSLTeam

When you picture a pyramid, you get the impression of new building blocks being added on to existing blocks, until an impressive structure is created, isn’t it? The pyramid trading strategy is a similar concept. The pyramid trading is an easy strategy that can be used be any investor, whether a novice or a veteran. 

You can use the pyramid trading strategy to add to your gaining positions without increasing your exposure to market risks. Interested in learning how this works? Read on to know more about what pyramid trading is, its pros and cons, how it can be a useful investment strategy. 

What is Pyramid Trading?

Pyramid trading is an investment strategy that involves purchasing more winning trades when its prices are trending in your favour. As it involves doubling down on an existing position, it has a potential for higher risk of losses, that is why it should be optimal for those investors who have a good understanding of the market and vast experience about price trends. Pyramid trading can prove to be greatly beneficial if it is well planned and well executed. 

Also Read: Positional Trading Strategy

Understanding Pyramid Trading: An Example

Let’s look at a hypothetical example to accurately understand how the pyramid trading strategy works in real life. 

Assume that you purchase 100 shares of ABC Limited at ₹50 per share. You expect the stock price to rise to ₹70 in the future. As expected, the stock price rallies and moves to ₹60 per share. Since the price moved according to your expectations, you decide to double down on your position by purchasing 80 more shares of the company at ₹60 per share. 

Once again, the share price rises to ₹65 per share. This prompts you to purchase 50 more shares at the price. Now, you have 230 shares of ABC Limited at an average price of ₹56.73 per share. 

As the share price touches ₹70, you decide to sell off your entire holdings of 230 shares. The profit that you get from the trade would be ₹3,052 [(230 shares x ₹70 per share) – (230 shares x ₹56.73)]. Now, if you had not executed the pyramid trading strategy, you would have been left with a profit of just ₹2,000 [(100 shares x ₹70) – (100 shares x ₹50)]. 

Thanks to this strategy, you were able to generate an additional profit of ₹1,052 (₹3,052 – ₹2,000).

Also Read: What is Pure Play?

3 Reasons Pyramid Trading Works

Pyramid trading is a well-researched strategy many short-term and long-term traders often use. Here are three reasons why such a strategy works. 

1. You Only Add to Winning Positions

Pyramid trading only requires you to add to positions where the price is trending in your desired direction. Since the strategy takes advantage of winning positions that display a consistent trend like higher highs and lower lows, it enhances the profits of a trade. 

2. There is no Increase in Risk

A major reason why pyramid trading works is the consistency in the risk. Unlike other strategies, your overall risk doesn’t increase with every additional position you take. Any new risk you take on, if any, will also be set off by the profits from your existing position. 

3. You Do Not Exit too Soon

With the pyramid trading strategy, you don’t book your profits too soon. Instead, you continue to accumulate further at multiple junctures. The strategy essentially pushes you to be more analytical with your trading and investment decisions and enables you to make multiple trades instead of just a single one. 

The Flip Side of Pyramid Trading

Although pyramid trading can amplify your profits, there’s also the risk of running into losses if the trend suddenly switches direction. As you continue to add to your position, the overall cost of investment increases. If the asset price reverses suddenly to the original entry price, it would not only erase all your gains but also lead to a significant loss. Therefore, it is crucial to implement a proper and thorough risk management plan. Also, it is not advisable to use the pyramid trading strategy in a fast market or a gap market since it makes it a lot harder to limit risk. 

Also Read: What is scalp trading

The Types of Pyramiding

Although the basic premise of pyramid trading remains the same, there are slight variations of it that traders use. Let’s look at some of the most popular variants of this strategy. 

• The Standard Pyramid

Also known as the upright pyramid, the standard pyramid involves entering into a large initial position. Each additional position you subsequently enter should be smaller than the previous one. For instance, if the first position was for 100 shares, the subsequent position could be for 80 shares and the position after that could be for 50 shares. 

• The Inverted Pyramid

The inverted pyramid requires you to maintain the same size for all the positions you enter into. For instance, if your initial position was for 100 shares, all the subsequent positions must be for 100 shares. This particular variant is more aggressive and riskier than the standard pyramid. Even a slight reversal in the price direction could eliminate all your profits. 

• The Reflecting Pyramid

The reflecting pyramid variant involves adding to your positions systematically till you reach a specific predetermined level. Once the level is reached, you gradually reduce your position by booking profits even as the trend continues to move in your intended direction. Compared to the other variants of the pyramid trading strategy, the reflecting pyramid is not very aggressive and generally leads to fewer returns. 

• The Maximum-Leverage Pyramid

The maximum-leverage pyramid is the most aggressive variant of this strategy. It involves adding further positions with the maximum possible size subject to the margin requirements and accumulated profits. The variant offers the maximum possible reward and the worst possible risk. 

Conclusion

Pyramid trading is often mistaken for averaging down strategy. Although the two may seem similar, they are not the same. In pyramiding, as you’ve seen above, you only add to winning trades. However, averaging down is a strategy used to reduce the average cost of investment, so you purchase more units of an asset when the price falls. This does not necessarily equate to adding to a winning position. 

Irrespective of whether you want to use the pyramid trading strategy or the averaging down strategy, you need to have a demat and trading account to buy and hold different kinds of shares and securities. Bajaj Financial Securities Limited can help you here — with a free demat and trading account that you can easily open on the official BFSL website or mobile trading app.