Adding to Position (Pyramiding)

‘Pyramiding’ loosely means adding to your position in a trade, i.e. buying more shares that you already own. So when would you buy more shares in a company that you have already invested in? Many investors make the mistake of ‘averaging down’, which is purchasing more shares as the price is falling. The reason they do this is because they believe that if a stock was cheap when they initially purchased the shares, it must be cheaper now. This is a massive NO NO as it goes against the principle of setting up stop losses and getting out of the trade when your stop loss is activated. Furthermore, you have no way of knowing how far the price of the stock is going to fall. Remember – capital preservation is essential for a healthy and prosperous trading experience.

So don’t buy more shares if the price in that company is falling!

It is accepted that the price of shares do in fact trend. Therefore, adding to your position makes sense when you have confirmed that the price is trending up. So when do you add? How much do you add? And how often do you add?

You could keep it simple and base it on %s, i.e. if the price moves up 5% buy more. If it moves up another 5% - buy more again, and so on. Or you could base it on an Average True Range (ATR) movement, i.e. if the price moves up ½ ATR or 1 ATR – buy more.

Trading Example

I will keep it simple for this example and use the 5 % rule to demonstrate how adding to your position can increase your profits. This article should be read in conjunction with my post on ‘Position Sizing’. Remember that I only want to risk a maximum of $1000 per trade and I use 2 x ATR as my stop loss.

Chart supplied by www.incrediblecharts.com

On the 20/3/09 I buy 1136 CRG shares at the open for $8.00 for an outlay of $9088 (1). The ATR of CRG on this date is $0.44 (4) therefore, my stop loss is set at $7.12 (Stop Loss is: purchase price minus 2 x ATR). At this stage, the most I can lose is $999.68 (1136 x $7.12 = $8088.32)

$9088 - $8088.32 = $999.68

On the 24/3/09 the price of CRG has increased by 5%, i.e. it reaches $8.40 (2). I now decide to buy more. The ATR is now $0.43 (5) and once again I only want to risk $1000 on this trade. My stop loss is now set at $7.54. To calculate the number of shares I am now going to purchase I divide $1000 by 2ATR:

$1000 / $0.86 = 1163 shares. Therefore, 1163 CRG shares are purchased at $8.40 for an outlay of $9,769.

I now own 2299 CRG shares that have cost a total of $18857. If the stop loss of $7.54 is activated, I exit both trades therefore, I sell 2299 CRG shares at $7.54 and receive $17334.46 (a loss of $1522.54).

On the 5/4/09 the price of CRG has increased another 5%, i.e. it reaches $8.82 (3). I now decide to buy more. The ATR is now $0.39 (6) and once again I only want to risk $1000 on this trade. My stop loss is now set at $8.04. To calculate the number of shares I am going to purchase I divide $1000 by 2 ATR:

$1000 / $0.78 = 1282 shares. Therefore, 1282 CRG shares are purchased at $8.82 for an outlay of $11,307.24.

I now own 3581 CRG shares that have cost a total of $30,164.24. If the stop loss of $8.04 is activated, I exit all three trades therefore, I sell 3581 CRG shares at $8.04 and receive $28,792.128 (a loss of $1373).

Now in this example, I would exit all three trades on the 14/5/09 on the open at $9.23 due to my moving average rules. So 3581 CRG shares are sold at $9.23 and I receive $33,052.63 (a $2888.39 profit).

Had I not added to my position, I would have only owned 1136 CRG shares that were purchased on the 20/3/09 for $8.00. I would have sold them on the 14/5/09 at $9.23, receiving $10,485.28 (a profit of $1397.28 ).

Adding to my position increased my profits by $1491.11 which is a 107% increase.

An interesting observation comes out of this example. Whilst I conducted three separated trades and risked $1000 per trade, my overall risk ended up only being $1373. Whereas if I had conducted three trades in three separate stocks, my overall risk would have been $3000.

Why would you not add to your position to a trend that is working in your favour? With proper risk management strategies, you can increase your profits while lessening your risk. Caution: do not put all your eggs into one basket. I only add to my position twice.