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Trading Strategy - Pyramid Your Profits!
By Jordan Weir
Are you one to throw caution to the wind, or do you cut your losses short, and let your profits ride? It may surprise you to realize that while many traders think they cut their losses short, and let their profits ride, there is a simple technique that will allow them greatly amplify those profits, while keeping their losses manageable. This technique is known as "pyramiding your profits".
The art of pyramiding your profits begins with good risk management. You should risk no more then 5% of your portfolio on any given trade, and many experienced traders use numbers as low as 2-3%. This doesn't mean someone with a $50000 portfolio can only invest in $2500 worth of a companies stock, it means that when they are setting their stop loss, they must be cognizant of how much they can lose on the trade.
So if a company is trading at $20 per share, and our stop loss is at $17.50, we can lose $2.50 per share by buying. If we're willing to lose no more then $2500, then $2500/$2.50 = 1000 shares. So we should purchase 1000 shares for this trade.
With your standard trade, that would be it. An order to sell at a certain price, and order to buy at a certain price, and a stop loss. When your pyramiding your profits though, there's an integral extra step. When the stock has gone up in price, and you have some profits, you add MORE to the position. Lets say it goes up to $22.50, and you decide to move your stop loss up to $21.00. You now have 1000 in gains if you get stopped out. To pyramid your profits, you add that 1000 in gains to your risk amount for the trade, for a total of $3500. Since its now at 22.50, and we can risk up to $3500, then we should purchase another 2300 shares. (3500/1.5 = 2334).
If it gets stopped out at 21, then you made gains of $1000 on the shares bought at 20, but you lost $3450 on the shares bought at 22.50, for a total loss of 2450, which is approximately how much you were risking on this trade. If it then continues to go up to $25/share, then you made $5000 on the shares bought at 20, and another $5750 on the shares you bought at 22.50, giving you a total gain of $10750, while only putting 2500 at risk. By adding shares, or "pyramiding your profits", you substantially increased the potential reward of the trade, while maintaining a safe level of risk, and by cutting your losses short, and letting your profits run, your ability to profitably trade the markets will be greatly enhanced.
Make no mistake; this strategy is applicable to long term investors as well. Assuming you're invested in an up trending stock, then adding shares to your investment whenever it breaks above the last high will greatly assist in maximizing the profits from the big overall trends that appear in the markets. If you're investing for longer time periods, its advisable to leave some profit in the case of it hitting the stop loss.
The interesting thing about this strategy is while it's almost the opposite of some conventional wisdom - you never go broke taking a profit - it does strongly adhere to the idea of cutting losses short and letting profits run. The key is to do more of what's working, and less of what isn't, and that's exactly what this kind of trade accomplishes.
The most successful traders in the market aren't the ones who are right on 80% of their trades. Many of the most successful aren't right on 50% of their trades. A few of them aren't even breaking 30 or 40%. What separates the best from the rest isn't how often their right, but how much they make when they're right compared to how much they lose when they're wrong. By pyramiding your profits, you'll make massive gains, and small losses, which is a key to becoming a successful trader.
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