As a trader, it’s a general rule of thumb that we should always be looking to maximise potential returns (per unit of risk) with each transaction. We should always be looking to squeeze as much out of the market as we can.
There are times when this can occur by simply letting the trade run its course. However, sometimes market conditions align perfectly for savvy traders to “press the trade” or “pyramiding” into the trade.
Don't press your luck; press the trade instead!
Attempting multiple entries in the direction of a trend is one strategy savvy traders use in an attempt to maximise return (otherwise known as Pyramiding). The problem with this tactic is that while it may increase the potential reward, having a larger position in the market also opens you up to more risk. As a trader, you need to find the perfect balance of pressing the trade while not pressing your luck.
There are a few ways to achieve this:
- If the market is moving at a snail’s pace, and not much movement has been made from the initial entry, any additional entry should be minor. If, however, a decent distance has been travelled, a trailing stop will secure more profit, and any additional entry can be larger. In essence, any additional position sizes are partly dependent on the distance between the initial entry position to stop loss.
- Ensure you have a strong driver that pushes prices along. Simply pressing trades at random is not good risk management.
- Reduce risk on entry by only adding additional positions when the stop loss on the first position can be trailed.
Pick your battles carefully when Pyramiding
You may find that as time wears on, you’re left with a large portion (>2% of total equity) in a single trade. The tactic of adding exposure will generally make for a “short” pyramid, which typically won’t grow over 2.5% of overall equity. This tactic ensures you’re exposed to additional upside while minimising downside to a level with which you’re comfortable.
Here are a few things to be wary of:
- Keep an eye out for drivers that influence market psychology: This is when momentum and volatility will be high, allowing you to pyramid into a move more easily. For the technical traders, you may prefer to avoid day-to-day shifts by taking in a broader market view.
- Diversify: as with any investment, don’t place all your eggs in one basket. Diversification is key to keeping overall risk low.
- Have strict risk limits in place: With 2.5% in one pyramid, another 2.5% in another – next thing you know, your overall portfolio heat is close to 10%. That’s a high amount of risk to carry around with you. Consider minimising position sizes of certain trades to reduce overall risk.
- Consistency is key with position sizes: If your initial entry is $100k and your second is $300k, you’re off to a lousy start in building your pyramid.
Final Thoughts on Pyramiding
Remember always to start small and slowly. There’s no need to rush in. Experiment with pyramiding until you’re comfortable with your approach. Always remember the two key elements to consider:
- Resist the temptation to take profit early when the opportunity arises. Sometimes it's best to sit on an existing trade.
- Be wary of adding to your trade at "worse" levels. Trends will always end at a certain point, so you don't want to be pyramiding into an extended, ongoing trend. Look for new trends to pyramid in, which will reduce your overall risk.
Risk Warning: Trading foreign exchange on margin carries a high level of risk and may not be suitable for all investors. The high degree of leverage can work against you as well as for you. Before deciding to trade foreign exchange, you should carefully consider your investment objectives, level of experience, and risk appetite. The possibility exists that you could sustain a loss of some or all of your initial investment and, therefore, you should not invest money you cannot afford to lose. You should make yourself aware of all the risks associated with foreign exchange trading and seek advice from an independent financial adviser if you have any questions or concerns as to how a loss would affect your lifestyle.