Market and Investment

If your seeing wild fluctuations in your trading portfolio, and not of the upwards kind, then your forgetting a critical piece of knowledge. To be a successful trader, you MUST cut your losses short, and let your profits ride. It is THE most important lesson to learn, right up there with using a stop loss, and key concepts like support and resistance. To be a highly successful trader, you need to learn to pyramid your profits, greatly amplifying your gains, and turning the big winners, into true home runs.

In order to properly pyramid your profits, you must understand a basic tenant of risk management. This tenant alone is enough to bring many an unprofitable trader to profitability, but only once combined with the idea of pyramiding profits, can its true utility be realized. This tenant states that no more then 5% of your portfolio should be at risk during any trade. Thus someone with a $50000 portfolio can risk $2500 on a trade. This doesnt mean they cant invest more then $2500, but it means that when setting a stop loss, your initial position size should be based on the $2500 number.

To determine your position size, what you do is you take the amount your willing to risk, and divide that by the amount your risking per share (the difference between the stock price, and your stop loss). So on a $20 stock, if your stop loss is at 17.50, and your risking $2500, then you do $2500/2.50 = 1000 shares. Your position size should be 1000 shares.

Now here is where the idea of pyramiding your profits comes in. If you think that $20 stock is going to $25, then with your 1000 shares, there’s a potential for $5000 in profits. Not bad at all, but that number could be much higher. After that $20 stock goes up to $22.5, you move your stop loss up higher, possibly to around $21.00. Now you’ve locked in gains of $1000, and you can add that to your risk amount of $2500 for this trade. You now have $3500 to risk on this trade. Since you can lose $1.50 a share from where you currently are, $3500/1.50= 2334. This means you should increase your position by another 2300 shares.

Now lets analyze your position for a second. You bought 1000 shares at 20, and 2300 at 22.50. If it goes to 25, then you made $5000 on the original 1000 shares, and another $5750 on the second set of 2300 shares. If it goes down to your stop at 21, then you made $1000 on the original 1000 shares, and lost $3450 on the second set of $2300 shares, for an overall loss of $2450 (about the same as the risk you were willing to take on). The same idea can be applied to shorting stock as well. Just remember ” add to your position as you become profitable, but keep your maximum loss relatively constant factoring in the unrealized gains.

Yet the applications of this strategy are important not just for the short term trader; it can be used by long term investors as well. Assuming its an up trending stock, long term investors would be well served to start with smaller positions, with a stoploss, and essentially add to the position on breakouts. This allows you to profit from the frequent megatrends in the market, while being taken out of the market if it begins going against you.

You may have heard the saying, you never go broke taking a profit. This idea is the polar opposite to pyramiding your profits, and is in fact, dangerous. To succeed in the investing world, your profits must be substantially higher then your losses, and that is whats accomplished by a trading strategy such as pyramiding your profits. Cut your losses short, and let your profits run.

The key to success in trading is to have big gains, and small losses. By doing so, you can be wrong half the time, and still make money in the market. By pyramiding your profits, you insure big gains and small losses. Using this stock trading strategy, you can truly cut your losses short, and let your profits run.