One of the staple techniques of trend following that helps many trend followers achieve those 100% years now and then is the practice of pyramiding.
Pyramiding is a technique used to add more to existing successful positions. Whilst never adding to losing positions. As a result, maximising the profits you make over time.
There are many different approaches to pyramiding your trades. However, I wanted to share with you the technique I use today and that I originally learned from my studying of highly successful trend followers such as Ed Seykota and Bill Dunn.
We need to address WHEN and HOW MUCH.
I use the concept of R Ratios to measure the results of my trades. I learned this from Van K Tharp, a strategy which measures the risk you took to reach that reward. When you risk £100 and make £100 profit, you make 1R. If you risk £100 and make £400 profit, that’s a 4R trade.
I add to my position when it reaches 1R. So if I go long on a stock risking £50, and it reaches £50 profit, I will add to my position. I will also look at adding again when it reaches £100 (2R). And again at 3R (£150).
When I first look to add to an established open position I will originally look to add 50% of my original position and then again in 50% increments of the previous trade. So if I buy 10,000 shares originally, I will buy another 5000 at 1R. Another 2500 at 2R, 1250 at 3R and 625 at 4R for example.
This protects you at the end of the move. For example, if the trade reaches 4.8R and then comes back down and closes as a 3.8R trade, you’ll only have lost money on the 5th instalment of 625 shares that you took out at 4R.
Using the above system we would never add to losing trades, as we only add when the trade reaches 1R.
There isn’t much of a downside here really. Obviously you will get some trades that start well, hit 1R, you’ll add another position at 50% and the price will fall and hit your exit signal resulting in an increased loss. However, whilst these can raise your losses slightly, they are nothing compared to the compounded effect on your profits. Think of it as injecting your trades with steroids. The losers are a little bigger, but the big winners are now extraordinarily bigger, massively outweighing the downside.
You can obviously change WHEN you add. You do not have to use the R concept to add. Some traders prefer to add on share price values for example. So they may add at £21, then at £22, then at £23.
That’s entirely up to you, and my advice would be to play with this concept and find something you like. You can always run the concept through backtesting to see what difference it would have made to your results had you been using it.