Do you throw caution to the wind, or do you cut your losses and let your profits flow? It may surprise you to realize that while many traders think that they cut their losses and let their profits flow, there is a simple technique that will allow them to greatly amplify those profits, while keeping their losses manageable. This technique is known as “profit pyramiding.”
The art of pyramiding your profits begins with good risk management. You shouldn’t risk more than 5% of your portfolio on any given trade, and many experienced traders use numbers as low as 2-3%. This does not mean that someone with a portfolio of $50000 can only invest in shares of a company worth $2500, it means that when they set their loss limit, they need to be aware of how much they stand to lose on the trade.
So if a company is trading at $20 a share, and our stop loss is $17.50, we stand to lose $2.50 a share by buying. If we are unwilling to lose more than $2,500, then $2,500/$2.50 = 1,000 shares. So we should buy 1000 shares for this trade.
With your standard trading, that would be it. A sell order at a certain price, a buy order at a certain price and a stop loss. However, when you pyramid your profits, there is an integral extra step. When the stock has risen in price and you have some profit, you add MORE to the position. Let’s say it rises to $22.50 and you decide to move your stop loss to $21.00. You now have 1000 in profit if you get caught. To pyramid your profits, add that 1,000 in profits to your risk amount for the trade, for a total of $3,500. Since it is now 22:50 and we can risk up to $3,500, then we should buy another 2,300 shares. (3500/1.5 = 2334).
If you stopped at 21, you made $1,000 profit on the shares bought at 20, but lost $3,450 on the shares bought at 22.50, for a total loss of 2,450, which is roughly how much you were risking on this trade. . If it then continues to rise to $25 a share, then you made $5,000 on the shares you bought at 20, and another $5,750 on the shares you bought at 22.50, giving you a total profit of $10,750, while only putting 2,500 at risk. stocks, or “pyramid your profits,” substantially increased the potential reward of the trade, while maintaining a safe level of risk, and by cutting your losses and letting your profits flow, your ability to trade profitably in the markets will improve. be greatly improved.
Not make mistakes; this strategy is also applicable to long-term investors. Assuming you are invested in a stock that is trending up, adding stocks to your investment each time it breaks past the latest high will go a long way in maximizing profits from big general trends appearing in the markets. If you are trading for longer periods of time, it is advisable to leave some profit in the event that you hit the stop loss.
What’s interesting about this strategy is that while it’s almost the opposite of conventional wisdom (never go broke by making a profit), it sticks firmly to the idea of cutting losses and letting profits run. The key is to do more of what works and less of what doesn’t, and that’s exactly what this type of trading accomplishes.
The most successful traders in the market are not the ones who are right in 80% of their trades. Many of the most successful do not get 50% of their trades right. Some of them aren’t even breaking 30 or 40%. What separates the best from the rest is not how often they get it right, but how much they win when they get it right compared to how much they lose when they get it right. By pyramiding your profits, you will make massive profits and small losses, which is the key to becoming a successful trader.