*This article was updated on July 17, 2018*
There's nothing nicer than getting into a Forex trade and watch the market cooperate and go your way. Well, there are probably a lot of things nicer, but for a Forex trader, if that's not in your top ten nicest things, then maybe a career change should be in order. To buy into the market and then watch other people buy at higher prices than you did, can add to both self-esteem and margin. Or even if you decide to short the market and watch the bottom drop out, can sometimes cause a giggle or two.
Watching Your Trade Gain Momentum
So, while you're watching your trade gain momentum on either side of the market, you're probably not equating this with loads of missed opportunities. Sure, you've made money on the trade. In the meantime, you probably don't want to know about the potentially large amount of money you've left on the table. But in real life, just because you're not scalping doesn't mean you should be inactive. If you're right, you should capitalize on being right. There are a couple ways to do this, but essentially it boils down to the same thing: Add to your winners.
Pyramiding up, on the other hand, when implemented carefully and correctly, multiplies your gains and, even if the top of the pyramid sustains a minor loss, your stop-loss order to cash in on the profits will ensure the maximum benefits of a trend you successfully jumped on.
If you start out by buying five at one point on your chart and the market moves your way; the next thing you should do is buy three – or four. Then buy three – or two more. This strategy is what I like to refer to as the “Forex Pyramid”. You can also add to your position in the same increments, if you'd like. When you're figuring out your average price, also take into account the quantity of your position. It adds to the pleasure of being right. You're not exposing yourself to further risks because you're price averaging up (or down, if it's a short position). Move your stop-losses up accordingly and your profit remains secure. In the meantime, you've given yourself the opportunity to maximize profits in a Forex environment that is finally moving your way!
Why Pyramiding Works
The theory of pyramiding works on both technological and psychological levels. When a trader starts to implement a pyramid structure, he won’t be as tempted to take profits too early because he’ll be more analytical on each trade reversal. Rather than rushing to exit the pyramid trader will wait to see if the reversal is just a pause in momentum or an actual shift in direction.
Pyramid trading also gives traders the opportunity to place more than one trade on a given opportunity, which means that there are multiple chances for success, instead of just one, a thought that can be reassuring to many traders. If the trader was prepared to open one trade for 1000 shares and he decides to stagger his moves in a pyramid strategy, he may end up opening more positions, which could increase the gains above what was originally expected.
Stumbling Blocks for Pyramid Traders
As pyramids are built with blocks, it makes sense that some of them could be stumbling blocks, or roadblocks to success. Markets that have a tendency to “gap” in price from one day to the next can cause stops to be blown too easily, which would exposure the trader to more risks as the price increases. In other words, a large gap can cause a larger loss.
Likewise, many Forex traders have embraced the opinion that if this method can work with profits, it can also work in limiting losses. I believe this theory to be surprisingly wrong. Do not add to losing trades. There is no such thing as averaging down. Just because you've added to a losing trade at a lower level doesn't mean you've protected yourself with a lower average price. You've added to a loser. Nothing more. And certainly nothing less. There is only one sure-fire way to handle a position that has gone against you. Two simple words: Get out. Then you take a step back and start over. Pyramiding down has a snowball effect that can be devastating. When a Forex trader does this, he's simply hoping the market will turn in his favor and narrow his losses because he's lowered his average entry price. It's throwing all discipline to the wind, and turning trading the Forex market into gambling. This, without doubt, is a recipe for disaster.