Trading Strategy: Pyramid Your Profits!
We've all heard the age old adage, cut your losses short, and let your profits run. Yet the vast majority of traders don't use this concept to its fullest. The proper application of this single, key piece of advice can be the difference between showing a profit at the end of the month, and showing a loss. This method is known as pyramiding your profits.
In order to properly pyramid your profits, you must understand a basic tenant of risk management. This tenant alone is enough to bring many an unprofitable trader to profitability, but only once combined with the idea of pyramiding profits, can its true utility be realized. This tenant states that no more then 5% of your portfolio should be at risk during any trade. Thus someone with a $50000 portfolio can risk $2500 on a trade. This doesnt mean they cant invest more then $2500, but it means that when setting a stop loss, your initial position size should be based on the $2500 number.
This can be easily demonstrated with an example. Let us say we have company XYZ trading at $20. There's strong support at $18, so we set a stop loss for 17.50. This means we have a potential $2.50 loss per share. If we are risking $2500, and can lose up to 2.50 per share on this one, 1000 shares should be our maximum position size.
With your standard trade, that would be hit. 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 youre 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.
This strategy is the natural embodiment of the saying, cut your losses short and let your profits run. Its also in stark contrast to another bit of conventional wisdom, you never go broke taking a profit. While its true that you never go broke taking a profit, the size of the profits in relation to the size of the losses is very important. Pyramiding your profits increases your stake in whats working, while cutting out what isn't, and that's how you make money in the markets.
The key to success in trading is to have big gains, and small losses. By doing so, you can be wrong half the time, and still make money in the market. By pyramiding your profits, you insure big gains and small losses. Using this stock trading strategy, you can truly cut your losses short, and let your profits run. - 23167
In order to properly pyramid your profits, you must understand a basic tenant of risk management. This tenant alone is enough to bring many an unprofitable trader to profitability, but only once combined with the idea of pyramiding profits, can its true utility be realized. This tenant states that no more then 5% of your portfolio should be at risk during any trade. Thus someone with a $50000 portfolio can risk $2500 on a trade. This doesnt mean they cant invest more then $2500, but it means that when setting a stop loss, your initial position size should be based on the $2500 number.
This can be easily demonstrated with an example. Let us say we have company XYZ trading at $20. There's strong support at $18, so we set a stop loss for 17.50. This means we have a potential $2.50 loss per share. If we are risking $2500, and can lose up to 2.50 per share on this one, 1000 shares should be our maximum position size.
With your standard trade, that would be hit. 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 youre 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.
This strategy is the natural embodiment of the saying, cut your losses short and let your profits run. Its also in stark contrast to another bit of conventional wisdom, you never go broke taking a profit. While its true that you never go broke taking a profit, the size of the profits in relation to the size of the losses is very important. Pyramiding your profits increases your stake in whats working, while cutting out what isn't, and that's how you make money in the markets.
The key to success in trading is to have big gains, and small losses. By doing so, you can be wrong half the time, and still make money in the market. By pyramiding your profits, you insure big gains and small losses. Using this stock trading strategy, you can truly cut your losses short, and let your profits run. - 23167
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posted by X - Men @ 12:40 PM
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