What is Pyramiding?
Pyramiding is an old trading strategy where a speculator adds to their position size by using margin from unrealized gains. This trading strategy is based solely on the power of using leverage and was made popular by one of the greatest traders of all-time, Jesse Livermore.
Example of Pyramiding Strategy
A pyramiding strategy is considered a risky investment approach, but with proper money management can produce stellar results. Recently the market has taken a hard nose dive, with little or no retracements. If a trader was short, this kind of market environment would have been a prime candidate for a number or pyramiding strategies. In the below chart, Citigroup took a beating from a swing high of $49 in early October to a low of $3 in November. In a pyramiding strategy a trader will want to add to their positions on each bounce. So, in the below example when the stock fell from $49 and then had a short rally up to $35, this would represent a 29% drop, which on margin would be a 58% gain on your cash. This additional 29% of paper profits would then be used to add to the short position at $35 for the ride down. This process of adding to the short position would have continued all the way down to $3. Which would have produced much greater returns than simply shorting the stock at $45 and riding it down to $3.
Negatives of Pyramiding
Pyramiding will only work properly in a trending market. This is because if you are trading in a choppy market, the short-term corrections will naturally float towards previous swing points, thus eating into your original gains. So, remember to only consider such a trading strategy when both the markets and stocks are trending heavily in one direction.