Basic Introduction to Pyramiding in The Forex Market

The act of pyramiding in forex trading can also be described as scaling-in and describes a method whereby a trader adds to an existing winning position in the direction of the trend. It is therefore the opposite to averaging down which occurs when a trader adds to his position as it goes lower in an attempt to reduce his average price.

If pyramiding is done correctly, it is possible to build a much more profitable position without taking on too much additional risk.

Trend following technique

The success of pyramiding relies on one of the fundamental aspects of forex markets which is that trends can persist over long periods. Because of these long term trends it is possible to add to a trade as the trend continues, building up the size and profits of the position.

For this reason, the most successful way to implement a pyramiding strategy is to start your first trade with a good sized position. The idea is to laid down a firm base and then add smaller increments as the profits build up. It’s therefore not possible to implement a pyramid strategy if you only trade with full risk on each trade.

Trading in this way, (scaling in with ever smaller increments) ensures that the average trade level is skewed towards your initial trade and thus helps to reduce risk. By following the trend upwards, you end up with a position that has a fairly low average price and this is beneficial in case the market happens to break down aggressively.

The difficulties of pyramiding

Although scaling into a position can be a profitable technique for a trend following strategy it is also a difficult thing to get right. For one thing, the type of trend that allows pyramiding to work occurs very rarely. In fact, strong trends that are best for pyramiding typically happen just 5% of the time. There’s also evidence that pyramiding works best on longer term timeframes than over shorter periods.

As well as this, if pyramiding is not done correctly it can cause a position to become top heavy and can actually increase risk. Effective pyramiding needs careful position sizing at regular and sustainable levels. In other words, you should not just jump in and add to your position just because it has gone up ‘x’ amount of pips.
When you want to pyramid it is best to add to a position using the same trading logic that caused you to open the trade in the first place. In other words if you entered the trade on a 5 week breakout, you should add to it after another 5 week breakout.

In the end, the only way to really benefit from pyramiding is to test it out first before you put it into practice. Doing so you can find out when the best time is to add to a position, how many times you should add to a position before stopping and how quickly you should scale out of the position when it starts to turn around.

Photo Credit: Abe World! via Compfight cc

About the Author
ForexTime Ltd (FXTM) is an award winning international online forex broker regulated by CySEC. Our mission is to maximize the value our clients derive from their most precious commodity, "Time"! By offering advanced and innovative services, optimal customer care and perpetual devotion to our clients, we will ensure that their individual needs are always met as markets continue to evolve over time. Visit ForexTime to learn more [space height="20"] [social type="facebook"][/social] [social type="twitter"][/social] [social type="google-plus"][/social] [social type="youtube"][/social]

Leave a Reply