[Disclaimer: all the information in this series of articles is for educational purposes only. The author do not claim or guarantee that the readers may benefit from the information provided.]
Pyramiding
Getting rich in the stock market is not about being right all the time. It is about limiting losses when wrong and going for the kill when right. When an operator happens to have found a winner, he shall look for opportunities for second or third entries (i.e. pyramiding) as the share price continues to go up, because only then he can make the most out of a strong uptrend.
The entry criteria are very similar to the rules of the first entry. The upper end of the twelve-month trading range is at least one time and a half of the lower end, and the price consolidates itself solidly above the first buy level. There is one additional rule, though, and it is that a Day of Ten must have occurred within a month after the initial entry. When it meets all three conditions, then one may consider the second entry.
The entry and stop loss rules of the second entry are as follows. After the price consolidates for at least ten trading days after reaching the new high, place a buy stop at one percent above the high. At the same time, move the global stop loss (first and second entry combined) to 8% below the second entry level. After that, the rules for trailing the stop and taking profits are just as described before. As one may see, it is all quite identical to how one manages the first entry.
However, in the second entry, the operator can be much more aggressive than in the first one. In the first entry, one only risks two percent of his account. In the second, though, he is already in the money, and he has some extra cushion to take additional risk. Therefore, there is a different way to calculating the position size of subsequent entries, and the illustration is as follows.
Suppose one buys a thousand shares of a company at $10.00. The price acts well and fulfils all the criteria for pyramiding, and the second entry level is at $12.00, with a stop loss at $11.04. The way to calculate the second entry size is as follows. When it goes from $10.00 (first entry) to $11.04 (second entry’s stop loss), there is a gain of one dollar and four cents. With a thousand shares, the gain is $1.04 per share times a thousand shares, which is $1,040. Here one only wants to risk half of the gain, which is $520. On the other hand, the absolute dollar amount of the stop loss is eight percent of twelve dollars, which is ninety-six cents. By dividing $520 by $0.96, one will find that the second entry shall be 542 shares.
If it is so unfortunate that things turn out wrong and it hits the stop loss, then it will close out the entire position while still keeping roughly half of the gain. Later, if things look right again, and the price sets up another buying opportunity later, then start it all over and risks 2% of your new trading capital in the latest entry.
Given the highly ambitious nature of the pyramid method, one usually pyramid only once after the first entry. If the price still shows an active breakout under a favourable general market tune, then one may consider a third entry, but no more beyond that. The rule of the third entry is the same as the second entry: risk half of the gain made by the second entry alone, buy at the new high and place a stop loss at eight percent.
In summary, here are the rules of pyramiding:
1. One shall only consider pyramiding after a Day of Ten has occurred.
2. The setup required is the same as the first entry.
3. Place a global stop loss at 8% below the entry.
4. Position size equals half of the gain made by the first entry.
This concludes the whole series of the articles on how I operate in the stock market. Thanks for reading.
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