By Vantage FX
In forex trading, the goal is to maximize your profitable positions and exit as cheaply as possible from losing ones. However, if you just open up a position, and then let the trade run until you hit your price target, you may be leaving money on the table. Pyramiding is a way of increasing your profits when following a trend – without increasing your risk.
What is pyramiding?
Pyramiding is simply increasing the size of your position as a trend continues. For example, you might enter a trade initially with a single mini-lot, and then purchase an additional mini-lot every time the price increases by 100 pips. Because you have already made a profit on your initial position, you are in effect reinvesting this profit without raising your overall risk.
A real-world example
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Let’s assume that USD/CAD is trading at 1.2715. Since the Canadian dollar has shown weakness lately, there is a very strong uptrend in the USD/CAD pair. Not only that, let’s assume that you see strong evidence that the trend is going to continue. You have $10,000 in your trading account, and so you decide to risk 1% of this – $100.
In fact, 1.2715 also turns out to be a key support level – the price has bounced off of this level recently. There is, however, a fair amount of volatility, so you decide to place a stop loss 100 pips below this support level at 1.2615. You buy one mini-lot, which corresponds to a risk of $100 – 10,000 units with a maximum loss of 100 pips per unit.
Now, the price rises to 1.2815. At this point, you are up $100. You move your stop loss up to 1.2715, and buy a second mini-lot. Your first mini-lot can’t lose money – you locked in your profits by moving the stop loss up to the original purchase price. At the same time, your second micro-lot only has a risk of $100, since the new stop loss is 100 pips below the purchase price. In other words, your total risk is still just $100, but your position is now twice the size.
The trend continues, and the price now hits 1.2915. At this point, you move your stop loss up again – this time to 1.2815 – and buy a third mini-lot. Now, you are guaranteed to make $100 on your first mini-lot and to break even on your second mini-lot. Your risk on the third micro-lot is $100. In other words, your total risk is zero – this is now turned into a free trade.
The trend then continues further, and you finally exit your full position when the price hits 1.3015. At this point, you have made $300 on your first mini-lot, $200 on your second mini-lot, and $100 on your third mini-lot. Your total profit is now $600. If you had just stuck with your initial mini-lot, then your profit would have only been $300 – so you have doubled your profits. At the same time, your total risk was never more than $100 in either case. You have taken a 3:1 reward/risk ratio and turned it into a 6:1 ratio for exactly the same price movement.
A few words of caution
While pyramiding may seem like a simple way of making more money on your trades, it only works when the market is trending strongly. If trading is choppy or range-bound, then pyramiding isn’t a very good idea. (There are other strategies that come into play when a currency pair is moving sideways in a channel, so it’s best to use these instead).
The other thing is that you need to have a price in mind for when you want to close your position. It’s no good to just keep scaling in again and again, as there will come a time when the market reverses. If your analysis tells you there is more room to go, then by all means add another lot. But if the market has already hit your target, it’s time to take your profits.
Finally, always remember to keep moving your stop loss as you pyramid, so that you always keep your risk the same. Don’t forget to do this, otherwise a rapid reversal could wipe out all of your profits – and more. Also, beware of leaving positions open over the weekend – if the market gaps in the wrong direction when it opens on Monday morning, then it could blow through your stop loss, leaving you with a significant loss.
About the Author:
This article was provided by the analysts at Vantage FX. Vantage FX specialises in Forex and Binary Options trading with MetaTrader.