Pyramiding Meaning Examples Pyramiding Strategy In Trading

Pyramiding Meaning

Investors and traders duly follow the movement of the stock parallel to other important factors and technical indicators and hence keep on investing in it, till the time the stock goes on to become more and more profitable. It’s a risky strategy, and only experienced investors are advised to do it.

Key Takeaways

Pyramiding is a trading strategy where investors add more shares of an asset inclined to its strong upward trend, ultimately increasing their margin.It is highly risky and is advised to be practiced only by experienced traders.It is only practiced when stocks showcase strong bullish behavior or upward potential.Pyramiding investment mostly works when traders take a small early position and have large funds and capital to increase their margin.

Pyramiding in Trading Explained

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Pyramiding is the simple trading practice of buying shares of a company in installments. It generally favors an investor who has started early or taken a smaller early position. When a trader buys a stock at a certain price and moves upward by 2% or 3%, the trader again buys a second lot, not necessarily of the same number of shares. Buying more of a stock or an asset when its market priceMarket PriceMarket price refers to the current price prevailing in the market at which goods, services, or assets are purchased or sold. The price point at which the supply of a commodity matches its demand in the market becomes its market price.read more is increasing refers to the practice of averaging up because the average price of the position goes up. It is a common practice in growth stock investing.

When a trader or investor invests in a particular stock, they want it to increase. The more the stock moves ahead, it validates an investor’s thesis, and thus, they buy more of the same stock or investment, raising their margin and creating a bigger position in their portfolio. Thus, the investor takes advantage of the positive trend and uses it to make higher returns.

In pyramiding investment, investors buy more of the security or asset in diminishing increments as its market price increases. The benefit of pyramiding is that investors buy more once the trade starts moving in their favor. However, it is risky because it may happen that after an investor has increased its margin, the stock price declines or falls below the profit marginProfit MarginProfit Margin is a metric that the management, financial analysts, & investors use to measure the profitability of a business relative to its sales. It is determined as the ratio of Generated Profit Amount to the Generated Revenue Amount. read more. It can also bring a huge loss to the investor; now, they are stuck with the investment until the price again moves higher or at least reaches a break-even price to exit the trade.

Pyramiding Parallels

The reverse of pyramiding trading, where an investor buys more securities when the price declines, is called averaging down or falling knife investing. It is a more popular and regular concept in value investing. An investor who believes in the future potential of the asset finds it the right time to invest more and more in the same security and decrease its margin. Common investors may also refer to it as the “buying the dipBuying The Dip“Buy the dips” refers to an investment strategy where an investor buys an asset when its price decreases, and overall, the price movement indicates an upward trend. In this strategy investor’s goal is to invest when the stock experiences a short-term price drop indicating buying at a bargain price.read more” scenario. However, it is a riskier strategy than averaging up.

A different approach to pyramiding is dollar-cost averaging. An investor keeps buying a set amount of securities in regular intervals (monthly. quarterly) no matter the market scenario.

Example

Take a look at this Pyramiding example. Alex buys ten shares of a company at $5. In a few days, the company stock grows up to $7. Alex believes that it has a huge potential. So he buys another ten shares, increasing its margin to $6. The same company’s stock price goes up to $9 per share. Alex has an unrealized return of $60.

When the share trades at $10, Alex again believes that there is a bullish environment in the stock market and again invests in the same company stock, only buying 50 shares at $10 per share. Executing this trade, Alex increases his margin again now to $8.85. This way, Alex increases his margin for the second time, and now, when the same company share trades at $12, he has an unrealized gain of approximately $220.

The downside is that if the same company share had declined to $5 after Alex had invested at $10, he would be observing a loss of $270.

Now let us consider the reverse of this pyramiding example. Suppose Alex goes on buying the securities even when the stock price is going downward. It will be a part of value investingValue InvestingValue investing is a long-term strategy that involves buying and holding undervalued securities, real estate, or other financial assets.read more. Let’s say that Alex buys ten shares of another company for $12 per share, and after a few days, the stock price moves down to $8 per share. But Alex believes that the company has huge potential and will strongly perform in the future. So he again buys ten shares at $8 per share, decreasing his margin to $10; now, when the stock price goes up to $12 again, Alex will enjoy a return of $40. It is the example of the opposite of pyramiding.

Pyramiding in Trading vs Pyramiding in Business

Many confuse the pyramiding trading strategy with a pyramid scheme. The latter is a fraudulent business practice that is illegal in many countries. Below are the key differences between the two: