The pyramiding strategy is said to be a powerful strategy as it can double your profit without increasing your risk. Here's the complete guideline to properly use it in forex trading.

Most traders enter the forex market hoping to get huge profits in a short period of time. For this reason, some of them start to look for the right strategy and stumble upon the Pyramiding strategy. If used properly, this strategy can turn small trades into big ones because the profits can increase significantly and even multiply them very quickly. We're talking about the difference between, let's say, making 200 pips profit in a single trade versus 2000 pips profit. Interesting, right?

However, there is a reason why not all traders use this strategy every time they trade. This technique can't be used under all market conditions and it will be more likely to bring more harm than good if you use it recklessly. Pyramiding your trades only works well at certain times where the opportunity is right. So to make consistent profits with this technique, you need to plan your moves carefully and trade strategically.

As profitable as it may seem, the pyramiding strategy can also be just as damaging if misused. Therefore, this article will explore the dynamics of pyramiding strategy by covering the fundamental concepts as well as the technical matters.

 

What is Pyramid Trading Strategy?

Pyramid trading is a strategy that includes scaling into a winning position, which means continue adding new positions to your trade as the trend moves in your favor to take full advantage of the profitable market and thus maximizing your returns. So basically, you are adding new positions to lock more profits without increasing the risk.

If done correctly, you can get a winning trade of two or three times the initial profit while simultaneously reducing your overall exposure. Remember, while it can multiply your profit in a strong trend, it can also be precarious if the trend changes direction. That is why pyramid trading leaves very little room for mistakes. You can only be either extremely right or just slightly wrong about your trade.

Take a look at the illustration below.

pyramid strategy

It shows that the trend is going upward (uptrend), making higher highs and higher lows. This condition is called the "stair-step" pattern, where the market is continuously breaking the resistance point and making it the new support line. It is the ideal condition for scaling into winning trade.

Before you make an entry, make sure that the trend is strong by looking at the higher highs and higher lows. Also, see if the correction or retracement does not hit the initial price before it goes up (in accordance with the Elliot Wave theory), ideally around 50% in the Fibonacci retracement.

The initial buy order shown in the illustration above is triggered when the market retests the former resistance level as the new support. A similar condition happens in the second and third buy orders, which are both triggered when the new support is formed after the former resistance is broken. To make sure when the retracement ends, you can use momentum indicators such as RSI, Stochastic, or price action formations from the candlesticks.

Before confirming the next order's entry, make sure that the price had exceeded the previous high. It is also worth noting that the market has to break through each level and is confirmed to be holding above the resistance to justify adding to the original position. This is why confirming the price momentum is a crucial requirement in pyramid trading.

 

How to Properly Use Pyramiding Strategy

The key to successful pyramid trading is to always maintain a proper risk-to-reward ratio, which means your risk should not be more than half of the potential return. Let's say the potential profit is 200 pips. You should keep the risk at or below 100 pips. As a result, you will get the 1:2 risk to reward ratio, also known as the "2R".

Moreover, the application of the risk management system can be seen in the stop loss implementation. In pyramid trading, you should scale your trades to a certain level while at the same time adjusting the stop loss level every time you enter a new position. The aim is to keep the same risk-to-reward ratio even after increasing your trade size. Thus, as you add the potential profit to your trade, the risk will remain constant.

Adjusting the stop loss level is very important because if you don't manage to apply it, the risk will continue to increase, potentially damaging your trade even more. Many traders may encounter difficulties when using the pyramiding strategy because they don't change the stop loss level to reduce the risk.

The detailed explanation about pyramiding strategy.

Based on the illustration above, let's say you open a $20,000 position. Every time the price retest the key level and form a new support level, you would buy 40,000 units (4 mini lots). While the potential profit may vary in each level, keep the stop loss at 100 pips. Assuming that the uptrend is clear, here is the scenario that you would expect:

  • You enter the market with your first trade and place your stop loss.
  • You decide to let the trade run because the market is in a strong uptrend.
  • The market breaks through the first resistance level and retests it as new support, so you buy 40,000 units (2% risk) as your second trade and trail your stop loss at 100 pips behind the second position.
  • Once more, the market breaks through the second resistance line and again, retests it as new support, so you decide to buy another 40,000 units. Don't forget to also trail your stop loss at the same length behind the third position.

At this point, you have built up a relatively large position size of 120,000 units. Interestingly, the risks from positions 1 to 3 have been kept constant at 2%. Notice that potential profit from each position is compounded throughout the trade, while the risk is continually mitigated.

This is the key to pyramiding strategy: you always keep the same trading risks and only open a new position when the previous position has their stop loss moved to lock in profits.

In other words, if your present trade is in a losing scenario, you will only lose on the most recent stop loss level because you already locked the profit from all the trades you took when the market moved in your favor.

When it comes to the profit itself, the initial entry would have given you a 12% profit, which is already relatively high on its own. However, you could double the gain up to 24% by using the pyramiding strategy without adding more risks. The worst-case scenario will be a 2% loss if the trend changes direction after your first trade, while the best situation would be a 24% profit if the trend keeps going strong after your last trade. In addition, your overall risk to reward ratio in this trade is 1:12.

When using the pyramiding strategy, one thing to note is that don't assume that you always have to pyramid your traders just because there is an opportunity to do so. The reason is that the method is not always effective in every market. Generally speaking, you should only use this technique when the trend is very strong or when the intraday's price movement is very active. If the trend is looking favorable but the momentum is weak, the pyramiding strategy is not recommended.

 

The Bottom Line

Pyramid trading is a trading technique that you should know as it can be extremely advantageous to your trade. If you do it properly, you can significantly increase your profit without adding to your risk. However, it is also vital to note that it isn't always easy to do and should not be used without proper consideration because not every market is suitable for pyramiding.

In fact, only certain conditions work well with this strategy and that doesn't come often. It does take some practice and experience to identify when is the right time to pyramiding into a trade or not. Nevertheless, considering the amount of profit you can get in a successful pyramid trading, it is definitely worth the time and effort.

Another essential matter is not to let greed control your actions. Make sure to plan how many positions you'll add to your trade, when you will add them, where to put and adjust the stop loss levels, and so on. If you just "wing it", you can possibly end up overtrading and perhaps losing more money.

Just be sure to manage your risk well in every trade by maintaining a proper risk to reward ratio at all times. Don't just focus on building up for the potential profit. Place the trailing stop every time you place a new order, or else, you will pyramiding your losses as well.

Lastly, only use the pyramiding technique in a trending market. Never add a new position to a losing trade. Only when the market is moving in your favor then you can consider pyramiding your trade. But if the trend is going against you and even moves back past your initial entry, you should immediately get out or let the stop loss automatically take you out.

The point is to be ive when choosing which market to use the pyramiding technique on. Only use it when you think there is a significant trend and the market is very profitable for you. Also, you should try it in a forex demo account before even thinking to use it straight in a live account.