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CFDs
Pyramiding provides windfall to CFD traders
Jeff Cartridge - August 22, 2007
 With the recent volatility translating into strong downward movements in the stock market pyramiding can dramatically enhance the profits a trader receives. Pyramiding is the art of adding to a position when the position moves in your favour. This achieves the trader’s goal of minimising risk on losing positions while maximising return on winning positions.
Consider a recent trade on SLX entered short on the 27th July as it broke down from a descending triangle pattern. The entry price was $10.60 and the initial stop was set 3% above the entry at $10.92 which would equate to a loss of 32 cents for every contract entered. The risk on this trade for every 1000 contracts sold was $320.
The position quickly moved into profit and a second position could be added when SLX moved 3% in a profitable direction. This first pyramid opportunity would occur if SLX fell to $10.28, which it did on the 1/8/2007. The opening gap would have the entry occurring at the opening price of $10.21 for this second position. By now adjusting the stop to 3% above the second entry the risk remains at $320 even though the position size is now double what it was previously.
A third position could be added if another 3% fall was to occur with SLX reaching $9.97. This happened on the same day as the previous pyramid. If sell on stop orders had been placed in advance both of these positions could have been entered the same day. Alternatively the third position could have been added at the open the next morning at $9.76. With a stop set at 3% above this entry the risk remains at $320 even though the position size is now three times the original amount.
A trader can go on pyramiding as many times as they choose to, provided the share continues to move in a profitable direction. Generally it would be recommended to add 2 – 3 times as the more times the position is added to the more risk of a loss occurring on the last addition. The trend will eventually run out. Some traders scale back the amount they add to the position on the second and third entries.
Profits were taken on this trade with a stop order placed after a gap occurred on the 10 August and this was executed on the 13 August. The exit was at $7.72 and the profit from the trade was a respectable $2880 per 1000 contracts without pyramiding into the position. By pyramiding into the position as described the profit on the same trade was $7410 per 1000 initial contracts or almost 3 times the profit of the trade without pyramiding (the total position size on this trade would be 3000 contracts after all the pyramid entries had been taken). The net result of the pyramiding is a position size three times the original amount.
This is not the same as entering three times the position size originally as the larger position size was obtained without increasing the risk on the trade. If the trade had not worked as planned, and SLX had gone up to hit the stop loss, the loss would have been $320 for 1000 contracts. If a larger position size was entered the loss would have been $960 for 3000 contracts.
CFDs are ideally suited to pyramiding into trades as they are easily executed with low transaction costs. Pyramiding is a powerful strategy to deliver profits to CFD traders while minimising the risk the trader takes on. The recent market environment where the trend has become established would have delivered fantastic profits to those already using this strategy.
Jeff Cartridge is the author of Supercharge Your Trading with CFDs. For more information go to www.superchargedreturns.com.au. Please note that the views expressed here are those of the author, not of CompareShares. Although all investing has some form of risk, CFD trading strategies are only for experienced traders and risk management strategies must be considered.
More articles from this week's CompareShares newsletter:
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Self-managed super: Old strategies are now even better
Sustainable investing: Climate change and consumers: hot air or real deal?
Fundamental analysis: Chief ratios for stock hunters - part 2
Resident Trader: Trading CFDs in a gapping market
Smart Investing: Experience tunes in to the market blues
Analyst report: Retail in a tailspin?
US markets: Long valuation waves and market fear
Sub-prime: Sub-prime what?
Ask the expert: Uncovering the average forex trader
Stock of the week: Mincor shares suffer from nickel freefall
CFDs: Pyramiding provides windfall to CFD traders
CompareShares Reader: Cloud gazing or tea leaves?
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