Pyramiding

Pyramiding refers to a trading strategy where an investor keeps on adding more shares of a company from time to time, increasing their margin inclined to the upward trend of the asset. This strategy is only used in a bullish environment or when the asset shows strong upside potential.

Investors and traders duly follow the movement of the stock parallel to other important factors and technical indicators and hence keep on investing in it, till the time the stock goes on to become more and more profitable. It's a risky strategy, and only experienced investors are advised to do it.

• Pyramiding is a trading strategy where investors add more shares of an asset inclined to its strong upward trend, ultimately increasing their margin.
• It is highly risky and is advised to be practiced only by experienced traders.
• It is only practiced when stocks showcase strong bullish behavior or upward potential.
• Pyramiding investment mostly works when traders take a small early position and have large funds and capital to increase their margin.

Pyramiding is the simple trading practice of buying shares of a company in installments. It generally favors an investor who has started early or taken a smaller early position. When a trader buys a stock at a certain price and moves upward by 2% or 3%, the trader again buys a second lot, not necessarily of the same number of shares. Buying more of a stock or an asset when its market price is increasing refers to the practice of averaging up because the average price of the position goes up. It is a common practice in growth stock investing.

When a trader or investor invests in a particular stock, they want it to increase. The more the stock moves ahead, it validates an investor's thesis, and thus, they buy more of the same stock or investment, raising their margin and creating a bigger position in their portfolio. Thus, the investor takes advantage of the positive trend and uses it to make higher returns.

In pyramiding investment, investors buy more of the security or asset in diminishing increments as its market price increases. The benefit of pyramiding is that investors buy more once the trade starts moving in their favor. However, it is risky because it may happen that after an investor has increased its margin, the stock price declines or falls below the profit margin. It can also bring a huge loss to the investor; now, they are stuck with the investment until the price again moves higher or at least reaches a break-even price to exit the trade.

The reverse of pyramiding trading, where an investor buys more securities when the price declines, is called averaging down or falling knife investing. It is a more popular and regular concept in value investing. An investor who believes in the future potential of the asset finds it the right time to invest more and more in the same security and decrease its margin. Common investors may also refer to it as the "buying the dip" scenario. However, it is a riskier strategy than averaging up.

A different approach to pyramiding is dollar-cost averaging. An investor keeps buying a set amount of securities in regular intervals (monthly. quarterly) no matter the market scenario.

Take a look at this Pyramiding example. Alex buys ten shares of a company at $5. In a few days, the company stock grows up to $7. Alex believes that it has a huge potential. So he buys another ten shares, increasing its margin to $6. The same company's stock price goes up to $9 per share. Alex has an unrealized return of $60.

When the share trades at $10, Alex again believes that there is a bullish environment in the stock market and again invests in the same company stock, only buying 50 shares at $10 per share. Executing this trade, Alex increases his margin again now to $8.85. This way, Alex increases his margin for the second time, and now, when the same company share trades at $12, he has an unrealized gain of approximately $220.

The downside is that if the same company share had declined to $5 after Alex had invested at $10, he would be observing a loss of $270.

Now let us consider the reverse of this pyramiding example. Suppose Alex goes on buying the securities even when the stock price is going downward. It will be a part of value investing. Let's say that Alex buys ten shares of another company for $12 per share, and after a few days, the stock price moves down to $8 per share. But Alex believes that the company has huge potential and will strongly perform in the future. So he again buys ten shares at $8 per share, decreasing his margin to $10; now, when the stock price goes up to $12 again, Alex will enjoy a return of $40. It is the example of the opposite of pyramiding.

Many confuse the pyramiding trading strategy with a pyramid scheme. The latter is a fraudulent business practice that is illegal in many countries. Below are the key differences between the two:

This has been a Guide to Pyramiding and its definition. Here we discuss pyramiding in trading, its explanation, example & compare it with a pyramid scheme. You may also have a look at the following articles to learn more –

• Pyramid Scheme
• Ponzi Scheme
• Multilevel Marketing