Adding to Trades - Pyramiding...
Adding to trades is an excellent way to increase your profits on winning trades.
If you have entered into a trade and you are currently in profit, your judgement so far is correct so in certain circumstances it may be a very good idea to increase the position.
For example: You entered a long trade on Gold September at $400 for £1 per point. Two weeks later, Gold is trading at $420 and so you are sitting on a potential profit of £200 (when trading Gold, a point is $0.1).
If the upwards trend still looks valid from the chart, it may be a good idea to buy another 50p or £1 per point to increase your position and profit.
In your trading plan you may decide to include a strategy to pyramid trades in this way. The following methods can be used:
(a) Adding to a trade after a certain percentage move in the market
This plan involves buying or selling into a market when it has moved a certain percentage in the direction you predicted.
For example: You open a trade on the DAX at 4000 and plan to add another unit of £1 per point if the market moves 2% in your direction. Therefore, you open a £1 per point trade at 4000 with a stop loss of 3920 and if the market hits 4080 you open another trade at this price.
Your total position now is £2 a point at an average starting price of 4040.
(b) Adding to a trade at the next moving average level
Say you are running a strategy where by you buy or sell when the market moves through the 200 day moving average. If the market then moves through the 50 or 100 day moving average, add another unit.
(c) Use the Average True Range (ATR) of the market
This is probably the best strategy as it takes into account the current volatility of the market you intend to trade. The ATR can also be used to form a solid money management plan.
The ATR is a measure of how much the market is moving per day on average. In the future, an article on this term will be added to this site but for now you simply need to know that it exists. ATR values for markets can be found from many different websites and also from programs such as ShareScope and OmniTrader.
In this example it is assumed that you are running a £10,000 account and risking 2.5% per trade (£250).
For example: Let's say it's June you want to place an UP trade on the Dow Jones September contract. The Dow is currently trading at 10375 and the 20 day ATR is 92.
On opening this position it would be sensible to let the ATR determine where to place the stop.
If the market moves against you for three straight days in a row it is fair to say that your judgement was wrong. Therefore, use 3 x ATR for the stop
i.e. 3 x 92 = 276
Now, your stop is 276 points way from your opening level so to risk £250 you need to calculate the risk per point
£250 / 276 = £0.9057... ~ £0.90 or 90p
Therefore, in order to risk £250 or less and use a stop of 3 ATR, you would buy the Dow at around 10375 for 90p per point.
Your total risk is now £0.90 x 276 = £248.40.
To add to this trade, wait for the market to move 2 ATR in your favour.
Therefore (as 2 x 92 = 184), buy another 1 unit (£0.90 per point) when the Dow has moved up to 10559.
If/when it moves 4 ATR above your starting price, add another unit and continue pyramiding like this.
Providing you use a trailing stop loss you can increase your profit as your trade moves in the right direction. At some point the upwards trend will finish but if you use a trailing stop of 2-3 ATR you will be closed out with a good profit.
Pyramiding is an excellent strategy when the trade is going in your favour but it must be stressed that you should never Average Down.
In terms of share buying, averaging down is the process of buying more shares when the price of the equity has fallen.
For example: Say you bought 300 Tesco shares at 320p. Two months later they have fallen to 300p so you buy another 300 at this price. You now own 600 shares at an average price of 310p. If Tesco rises again, you are more in profit than you would've been if you had stuck with the original 300 shares. However, if it falls further you stand to lose much more.
Averaging Down is a massive no-no when spread trading. Never try to do this to "get even" with the market.
Losing trades are part of trading and you must learn to live with them.
With the correct money management and by pyramiding successful trades you can afford to lose more trades than you win and still make money.
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