Stock Trading Strategy: Pyramid Your profits!
Are you one to throw caution to the wind, or do you cut your losses short, and let your profits run? It may surprise you to realize that while many traders think they cut their losses short, and let their profits run, there is a simple technique that will allow them greatly amplify those profits, while keeping their losses manageable. This technique is known as pyramiding your profits.
The art of pyramiding your profits begins with good risk management. You should risk no more then 5% of your portfolio on any given trade, and many experienced traders use numbers as low as 2-3%. This doesn't mean someone with a $50000 portfolio can only invest in $2500 worth of a companies stock, it means that when they are setting their stop loss, they must be cognizant of how much they can lose on the trade.
To determine your position size, what you do is you take the amount your willing to risk, and divide that by the amount your risking per share (the difference between the stock price, and your stop loss). So on a $20 stock, if your stop loss is at 17.50, and your risking $2500, then you do $2500/2.50 = 1000 shares. Your position size should be 1000 shares.
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).
So to recap. Stop loss at 21, we bought 1000 shares at 20, and 2300 at 22.50. If it goes down to 21, we gain 1000 on the first 1000 shares, and lose 3450 on the batch of 2300 shares, for a total loss of $2500 " the original risk amount. However, if it goes up to 25 as we originally forecast as our profit target, we've made $5000 on the original 1000 shares, and another $5750 on the second batch of 2300 shares. This is a total gain of 10750, while never risking more then $2500 in capital. The same idea can be applied to shorting as well. Its all about doing more of whats working, and less of what isn't.
Yet the applications of this strategy are important not just for the short term trader; it can be used by long term investors as well. Assuming its an up trending stock, long term investors would be well served to start with smaller positions, with a stoploss, and essentially add to the position on breakouts. This allows you to profit from the frequent megatrends in the market, while being taken out of the market if it begins going against you.
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 most successful traders in the market aren't the ones who are right on 80% of their trades. Many of the most successful aren't right on 50% of their trades. A few of them aren't even breaking 30 or 40%. What separates the best from the rest isnt how often their right, but how much they make when they're right compared to how much they lose when they're wrong. By pyramiding your profits, you'll make massive gains, and small losses, which is a key to becoming a successful trader. - 23222
The art of pyramiding your profits begins with good risk management. You should risk no more then 5% of your portfolio on any given trade, and many experienced traders use numbers as low as 2-3%. This doesn't mean someone with a $50000 portfolio can only invest in $2500 worth of a companies stock, it means that when they are setting their stop loss, they must be cognizant of how much they can lose on the trade.
To determine your position size, what you do is you take the amount your willing to risk, and divide that by the amount your risking per share (the difference between the stock price, and your stop loss). So on a $20 stock, if your stop loss is at 17.50, and your risking $2500, then you do $2500/2.50 = 1000 shares. Your position size should be 1000 shares.
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).
So to recap. Stop loss at 21, we bought 1000 shares at 20, and 2300 at 22.50. If it goes down to 21, we gain 1000 on the first 1000 shares, and lose 3450 on the batch of 2300 shares, for a total loss of $2500 " the original risk amount. However, if it goes up to 25 as we originally forecast as our profit target, we've made $5000 on the original 1000 shares, and another $5750 on the second batch of 2300 shares. This is a total gain of 10750, while never risking more then $2500 in capital. The same idea can be applied to shorting as well. Its all about doing more of whats working, and less of what isn't.
Yet the applications of this strategy are important not just for the short term trader; it can be used by long term investors as well. Assuming its an up trending stock, long term investors would be well served to start with smaller positions, with a stoploss, and essentially add to the position on breakouts. This allows you to profit from the frequent megatrends in the market, while being taken out of the market if it begins going against you.
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 most successful traders in the market aren't the ones who are right on 80% of their trades. Many of the most successful aren't right on 50% of their trades. A few of them aren't even breaking 30 or 40%. What separates the best from the rest isnt how often their right, but how much they make when they're right compared to how much they lose when they're wrong. By pyramiding your profits, you'll make massive gains, and small losses, which is a key to becoming a successful trader. - 23222
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posted by X - Men @ 2:11 AM
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