Pyramiding is one of those things in trading, which many people know about but only a few are able to use it correctly.

Today we are going to look at all the aspects of pyramiding, i.e What it is, why we should use it, Different ways to do it, pitfalls of pyramiding, etc.

So, let’s deep dive into it, shall we?

First, we will start by understanding what pyramiding is?

So, Pyramiding in simple terms is adding to your winners, i.e when a trade moves in your favor, you will add more qty to it.

Averaging is just the opposite of pyramiding. It's adding to the losing positions, i.e you add more qty when the stock shows you some loss, to lower your cost/avg. Price.

Why should we do Pyramiding?

Pyramiding is essentially a scaling-in technique.

Like, there are various ways you can enter a stock ~

1. You could take full risk in one go, i.e Enter full qty whenever you get a signal, this is known as the All-in technique.

2. You could break that risk into different parts, and add when the trade goes in your favor, that’s what we do in Pyramiding/scaling-in.

We divide our total risk per trade into say 3 parts (you can choose that as per your convenience), and whenever we get a buy/sell signal, we take 1/3rd of the total risk, and we will keep increasing the risk to our full total risk, as the trade goes in our favor.

So, there are different ways to look at it.

For some, it’s a way to reduce drawdowns, For some, it’s a way to make asymmetrical gains, for some it’s just a way to make their Equity curve smoother, For some, it’s just a gimmick ;)

So, it totally depends on the person who uses it, as to how he wants to use it.

Let’s look at all the Advantages of using pyramiding.

1. Your Avg. Losses would be way smaller than Avg. your Profits.

This is probably the number one reason why Traders use Pyramiding, as it helps you get good-sized gains and reduce your losses at the same time.

But how?

Well, Because In pyramiding, you enter in a trade with only a fraction of your total risk.

Let’s understand by taking a simple example.

Say you want to enter a stock at 100, with your stop loss at 95, and you are taking a 3% risk on your 100k account, i.e 3K risk.

So, If you are using an All-in technique, you would buy 600 qty, i.e Qty = Risk / (Entry - SL).

But, if you are using a scaling-in technique, you would divide the risk into three parts, i.e 1% each, so you would only buy around 200 qty, at one time, and will add the other two parts (200 qty each) at every 1R move in your favor (R = Entry - SL, here its 5rs)

Let’s first take a scenario where the stock hits your stop.

So, with an All-in technique, you would lose 3k.

But, if you are using pyramiding, you would have entered only 200 qty, so you would have lost only 1K on this trade.

Now, let’s take a scenario where your stock goes to 120 rs.

In an All-in technique, you would make about 20*600 = 12k profit.

Though In the case of pyramiding, you would have made your first entry with 200 qty at 100, and then you would have added 200 qty at 105, and then 200 qty at 110, so your average price would come to be about 105 with 600 qty.

So, you would make a profit of 600*15= 9k.

You might say that the first guy who was using an All-in technique made more profit than the second one who is using the pyramiding technique, right?

Yes, In absolute terms, the All-in guy would make more money than the one who’s using pyramiding.

But! If you compare the gains to the risk that they took, the All-in guy made only 4 times the risk he took, as he risked 3k to make 12k, but the second guy made 9 times the risk he took, as he risked 1k to make 9k.

So, basically, the one who’s using pyramiding would have smaller losses and huge winners as compared to the one who’s using the All-in technique.

Though, It’s not that straightforward, i.e what if the stock reverses after you do the pyramiding, right? That’s where you would have to learn to make your entries Risk free, we will talk about it later in the article.

2. Saves you during the whipsaw Market regimes.

One of the big reasons for big drawdowns/losses is the whipsaw period that we see quite often in the markets.

So, what happens is you enter with full position and the market reverses, hits your SL, and then forms a new setup, you enter again and it reverses again, and sometimes this gets so frustrating, that the traders end up losing more than they should.

So, To keep yourself sane during whipsaw markets, you should use Pyramiding.

Because then you would only risk a fraction of your total risk, and if the market shows some direction then we can add more risk.

So, when the markets give big trending moves, you would be on board with full Risk, and when it doesn’t, you would lose very little.

3. It helps to Keep your Equity curve smooth.

Look at the below two Equity curves, which one looks better to you?

The second one has made more money, right?

But now tell me, which one would give you more psychological pressure?

The second one, right?

See, It’s very easy to say that we can handle sharp drawdowns but in reality, Most traders give up or become undisciplined during those periods, which in turn give them more losses.

Whereas a smooth equity curve might not give you the best return, surely it would help you to stay disciplined and calm during the period where losing streaks come.

Of course, this is From a Point of view of a discretionary trader and for me, my mindset is my biggest weapon, and if it goes under too much stress, most likely I'm not going to perform well as a trader.

Now, let’s move on to the different ways by which you can do pyramiding.

There are basically two ways by which you can do pyramiding ~

1. Discretionary way (based on price action).

2. Systematic way.

Both have their advantages and disadvantages, depending upon your style, time frame, and mindset, you can choose whichever way suits you more.

1. Discretionary way of Pyramiding.

See, Most of us look at the discretionary way of trading, as undisciplined or Random. Well, it might be true for some traders, But, it’s not that simple. Discretionary means something which is left to individual choice or judgment.

Now, it’s up to the quality of the decisions one takes, which will decide the fate of that trader.

Being a discretionary trader does not mean that you don’t have rules or you don’t follow a process, It’s just that we believe that markets keep evolving with time, and we have to keep evolving ourselves in order to cope up with the markets.

This was just to clear that discretionary does not have to be random, though being a disc. Trader, I can say that you need a lot of patience and discipline, and it’s definitely not easy.

So, As you know we all see price action differently, and we have different setups for entries as well as exits.

So, what I’m going to explain here is how I use price action to do pyramiding.

See, when we are pyramiding, we are basically increasing our cost price, right?

So, if we add qty at random points, it might do more harm than good, so what I do is I consider each pyramid as a different entry, so basically I wait for a fresh Entry setup to evolve to do pyramiding.

And for that, we use price action.

These are some of the setups that I use while making a fresh entry or while doing pyramiding ~

1. Volatility Contraction breakout.

2. Shakeouts.

3. Normal movements.

4. Breakouts of rejection candles.

5. Urgency breakout.

So, let’s get right into it.

1. Volatility contraction Breakout

In my opinion, some of the best Breakouts happen after the volatility dries up to a level that there is no room for a further drop in it.

Basically, we are looking for the breakout of narrow range price action, as it provides the best R:R.

This concept could be best visualized by using a VCP pattern, A VCP is where volatility and volumes decrease, and the stock makes a narrow range.

You might have also heard of IB (inside bars), that’s also an example of Volatility contraction, where the volatility of successive bar(s) drops by more than 60-70%.

Things to remember while Trading Volatility contraction ~

1. Volumes should reduce with every contraction, as it signifies that the supply is drying up.

2. Every contraction should be 50% less than the previous one Timewise as well as price-wise.

3. The location of where a volatility contraction appears also matters, an All-time high stock will have a better chance of a successful breakout compared to the one happening around 52-week lows.

Some Volatility contraction examples ~

1. Though this is an ongoing trade, and we don’t know how it would behave from here, I thought that it would be better if I add recent examples like this one, as it will give you better insights as to how trades develop.

As, you can see that volatility was reduced about 40-50% on each contraction time-wise as well as price-wise, note that you won’t get picture-perfect VCP every time, so you don’t have to focus too much on the numbers and focus on why it works, like the time-wise correction on the second contraction was only 30%, but it would still work.

Also, one thing to remember is that the first contraction should not be more than 35% (on the daily chart), because if the 1st contraction is too big, then it shows that there are some serious sellers on the upside, so we would skip those setups.

This was not a pyramiding example, it was just to show you how to spot a VCP.

2. In the above chart you can see that after giving the Breakout the stock went into consolidation, and the range started getting narrower, and when the range became really small the stock gave a huge breakout.

This is one of the best examples of volatility squeeze, where the stock goes into consolidation, and the range keeps getting narrower followed by a huge move.

Let’s take a look at another example.

In the above chart, you can see that after the first big contraction, the price went into consolidation, and the volatility reduced significantly from a 25% swing to now 3-4% range.

The stock gave a 40% up move after breaking out of the range.

2. Shakeouts

A shakeout is when the stock undercuts some important support levels and then retraces back above those levels with speed, Signifying that the weak hands have exited the stock during the volatile move.

The breakouts which are preceded by the shakeouts are highly likely to be successful.

One thing to remember is that the price should retrace back with speed, also this should not be considered as a reason to not place SL’s, if a stock hits your level, just exit, don’t expect every breakdown to be a “shakeout”.

Let’s look at some examples ~

It’s a weekly chart, and you can see that after making the first contraction the price was trying to make a narrow range, but then some sudden selling comes and the “shakeout candle” broke below the last 7 week’s low, but the selling didn’t sustain and the price went back to where it was before.

Now, the weak hands are out, and the stock gives a strong breakout.

Another example of a shakeout ~

A squat also has a similar structure to that of a shakeout, basically, a squat is a kind of shakeout which happens after the breakout.

In this setup, the stock falls below the Breakout point, but does not give any follow-up selling, and again retraces back above the breakout point, which means that the buyers are still in the game, and we get an opportunity to add more qty.

This usually happens when a breakout occurs without forming a Narrow range.

3. Normal Reaction

It is basically when a stock takes a breather after an initial move, i.e a retracement on low volumes.

We all know that when a stock is in an uptrend, it moves with a higher-high and higher-low formation, but the up moves are stronger as compared to the down moves, also the down moves come with relatively lower volumes as compared to the up moves.

So, here what we are trying to do is we will pyramid when a normal reaction ends, and the stock resumes its up move.

You can pyramid once the high of the normal reaction has been taken out, or you can pyramid above any pivot which forms inside the normal reaction, the key point is that the volume should increase when the high of the range is broken.

The main thing to notice during this period is the force by which the selling is taking place, basically, the down days should not be too big and should have low volumes compared to the volumes to the up days.

If the volumes and the size of the candles increase on the down days, then it’s an abnormal reaction, which means that the stock is facing some serious supply, and can go further down from there.

4. Breakout of Rejection Candle

A rejection candle is when the price finds some serious seller before, or on the day of the breakout, and falls badly, but the next day the buyers try again with full force and again give a breakout, that’s what we call the breakout of rejection candle.

Basically here we are betting for the sudden change in sentiments, from a big down day which closes at the lowest point, to the next day where buyers push hard to cross the previous day’s high, this shows that the buyers are in control for now.

It’s not necessary that the stock should give a breakout the very next day after the rejection candle, if a breakout comes in the next 3-4 days it would still be valid, but here you should keep an eye on the volumes and the follow-up action, volumes should be low and we should see some narrow range candles after the rejection candle.

5. Urgency Breakout

As the name suggests this setup makes use of the “urgency” shown by big institutions when they want to accumulate a stock very badly, so they keep on buying as the price goes higher.

I usually use this setup on a weekly time frame, here we will pyramid when the stock breaks out of the last 4-8 week’s High.

Another example of Urgency breakout ~

Now, as we discussed at the starting of this article, what if the stock reverses after you pyramid, right? It would do more harm than good, so to counter that we have to learn how to make our entries risk-free so that we can pyramid without increasing our risk.

How to make your Entries Risk-free ~

Here, by risk-free what I mean is that we have to minimize the Open risk, (open risk is the max loss that you would bear if all your stop losses get hit at the same time/day.)

Let’s take a simple example to understand how to make your entries risk-free.

Say you enter in a stock at Point A with 1R SL, you risked 0.5% of your capital and you will trail your SL with every 2R up move.

So, now you will have to avoid any pyramiding opportunity before your SL reaches at your cost so that you won’t have any open risk.

After your entry the stock takes a breather (normal movement) and retests the breakout levels, this is a perfect opportunity to pyramid, but if you do that your risk will increase to 1%, and you don’t want to do that right?

So, you will skip this opportunity and wait for your first entry to become risk-free.

After the retracement, the stock again resumes its upward journey, and at point D your Trail your SL to your cost, so now you have no open risk, and you can add more qty if you get an opportunity.

After that stock gives a breakout of the narrow range, so you can take 0.5% risk at point E, your SL will be 1R away from your Entry, and your initial entries SL will still remain at cost.

After the stock gives another 2R move, you can trail Both of your SL’s to point G.

So, now you have 2R locked profit in the first entry, and no risk in the second entry, and you can add more qty if you get an opportunity.

So, this is how you can add more qty, without adding more risk, of course, this was just a simple example, and things won’t be that easy when you do it in real life, but still, you might have got the idea of how you can make your entries risk free.

Let’s take some real trade examples to get more insights into Pyramiding.

The stock was consolidating near the All-time highs, and a cup and handle kind of pattern was also developing, so a big breakout was on the way.

After which the volatility dries up in stock, and the range became narrower, i enter at around 225 when it broke above the trendline as you can see on the chart, and my SL was 218 (1 ATR away).

Here 1R is 7 rs. (R = Entry - SL)

The very next day, the stock moved 15% up and gave a breakout of the bigger range, but it found some sellers at the highs, i,e 260, and it closed around 240 that day, but I kept on holding as the breakout was still intact.

I trailed my SL to cost, so I did not have any open risk so that I can pyramid if any opportunity appears.

For the next few days, the stock again went into consolidation (Normal reaction) and formed a narrow range, which was good because it was sustaining above the breakout level, and the volume action was also good, as the volume was very low on the down days compared to the up days.

Now, I added 1X qty at 248, with SL at 240 after the narrow range breakout, At EOD I trailed the SL of the first position as well as the pyramid Position SL to 240.

So, now I have 2 R profit locked in the first position and my pyramid position is risk-free, so even if the stock hits my TSL, I will make a 2R profit, but if it goes up, I will enjoy the benefit of having 2X position.

After that the stock kept going up, and didn’t give any solid pyramiding setup, though there was a shakeout setup, but I skipped that one as I was already sitting on good gains, so I didn’t feel comfortable adding there.

I sold 1X qty at 285 with more than 8R gains, and i held the half qty, the reason for selling half qty was that it looked like a breakout failure to me at that time, but the stock just kept going higher, and when it showed some serious selling (5 out of 6 candles were red) then i exited the pyramid qty at 315 with almost 8 R gains.

So, I made almost 16 R gains from this trade, And Half of the gain came from the pyarmiding qty.

Example ~

2. Systematic way of pyramiding

In a systematic way, you’ll have all of your pyramiding levels pre-defined, and you won’t have to decide when to pyramid, or where you would place your TSL’s.

These are a few of the ways by which you can pyramid systematically ~

1. R-based Pyramiding.

2. Structure-based pyramiding.

3. DC (Donchian channels) based pyramiding.

4. ATR based pyramiding.

We will discuss all of these some other day, otherwise, this article would be super long.

Pitfalls of Pyramiding

1. Gap Risk!

For positional players there is always a risk of price opening 10-20% below their SL levels, so even if we make our entries “Risk free” we have to keep in mind that we don’t have any control over what happens overnight, so if we give too much concentration to a single position, we should be ready to see some deep cuts in our Equity curve at some point in time.

Don’t put your eggs in too many baskets, but don’t put them all in one either, you have to have some balance in the allocation that you give to a single position, like i see many traders who gets to know about pyramiding, putting all of their account in a single stock, not thinking about the worst consequences.

Most of the traders focus on how much money a system can make, but most of them usually don’t have much insight into how much the system can take away if shit hits the fan, and that’s why only a few survive in this game over the longer term.

2. Is it a Holy grail strategy?

Many people are under this impression that pyramiding will magically turn them into profitable traders, but that’s not true!

Pyramiding is a good tool in your trading arsenal, but it can only help you if you already have an edge in the markets.

And it’s not like if you don’t use pyramiding, you won’t make money. Everyone has a different style, personality, risk appetite, method, etc.

I know people who are using all-in techniques making money as well as those who are using pyramiding, so there's no right or wrong way of trading.

In this article I gave you a basic framework of how to do pyramiding, but now you have to put in the work to see if pyramiding is made for you or not, or how you can modify it as per your needs/Risk.

So, that’s it for today from our side, if you learned something from this article, then do share it with your friends over social media.

Thanks for reading :)