Today I’m taking a slight detour from our usual options talk and I’m diving into a longer term strategy focused on trading shares of stock using pyramiding. Sounds like an Egyptian monument, right? But in the trading world, pyramiding is a technique of adding to your positions based on price or time. Basically as the price of your stock goes down, you're buying more shares. You're building, bigger layers as you go down, essentially making a pyramid as shown on the chart below.
As a reminder, this is not trading advice, I am not a financial advisor nor am I recommending you setup or trade the following examples.
This is priced based pyramiding: you buy more shares as the underlying goes down:
This is time based pyramiding: you have more shares over time.
I know you might be thinking, "That's it? Just keep buying more shares?" Well, yes, and no. Pyramiding isn’t just about adding more shares, it’s about adding them strategically. Just like everything else there is no one-size-fits-all approach, this strategy works will all account sizes (if you can own 100 shares there are more benefits), and you need an exit plan if the stock keeps going down so you don’t lose all your capital!
I’ll also discuss how I pick my levels, go over a couple variations, and of course discuss how we can also use options to pyramid, protect, and possibly even add a little extra cash flow.
How to Pyramid Effectively: Two Approaches
1. Price-Level Pyramiding: (First image above) Here, we increase our position as the stock price hits certain predetermined levels. For instance, let's say you are interested in a company trading at $100, buy 10% of your total allocation at $100. If the price hits $80, you would buy another 20% of your total allocation. If it hits $70, you would buy 30 then at $60 you would by 40%. This way, you're adding more weight to your position as the stock pulls back and reducing your cost basis. Of course depending on your account size and the price of the shares, your number of shares will vary, but the principal works the same. Hedging with options will be slightly different in terms of leverage, but we will discuss that below.
2. Time-Based Pyramiding: With this method, you buy a fixed number of shares at regular time intervals, regardless of the price. As time goes, you have more and more shares. For example (see second image above) if you want to buy $1,000 of an underlying, you break your buying into an average of 5 buy across the next 5 weeks (or months). This approach helps to smooth out price fluctuations and lets you accumulate shares over time. Lets say you wanted to buy $1,000 of Delta Airlines (stock ticker DAL) and the stock is currently trading around $40 a share. (1000/40= 25 shares) So a time pyramid would look something like buying 25 shares every Friday (you could chose 25 shares a month as well). It’s all dependent on your objective and timeframe, but personally once a week is my as short as I would ever go.
There's a place for both these methods in your trading, I love the buy low, sell high philosophy, but sometimes stocks don’t dip enough to get all the levels conversely sometimes they keep dipping way lower than you want! If you buy over time you are getting the exposure (positive delta) you want which is great in a bull market. But, remember pyramiding requires planning ahead of time and a clear exit strategy (both for a win and a loss). It’s essential to have a ‘line in the sand’ where you'll cut losses if your thesis changes or if the market turns against you. No one wants their pyramid to turn into a pile of rubble! I normally try to pyramid into companies that I can own at least 100 shares, because there are more options such as covered calls, collars, and strangles we can use to bring in more income! I will be discussing these in upcoming articles. Just know with 100 shares (or lots of 100 shares) you are opening yourself up to more income as we discuss daily here at GKT!
How do I determine my price based pyramid levels:
When in doubt, I zoom out! So instead of looking at the daily chart I zoom out to the weekly chart and I always keep the 100 and 200 moving averages on my chart.
As you see on the chart above: I have a few more moving averages and I also like to draw weekly support and resistance (the purple lines you see). I draw my buy lines where I see support and moving averages. When you zoom even further out to the monthly chart you can see 100 and 200 moving averages are REALLY far away right? That is why you need to have a protective line in the sand. If you don’t have 100 shares of the company you will be over insuring your position, which isn’t always a bad thing, if MSFT keeps going down and you only have say 50 shares you are actually going to make money on your position as the underlying pulls back.
You can also use Fibonacci retracement tools. Here's the thing: you can set your levels however you want! Just figure out what works for you, and ALWAYS have a line in the sand where you are cutting your losses. Everything works, just not all the time, but don't let emotions or fear hold you back! Make a plan and get to trading, you miss all the trades you don't take.
If you are buying shares they never expire so you do not have to worry about calls expiring worthless. That said I do some more speculative pyramids using put sales as well. Depending on your account size and your conviction of an underlying you can sell 1 put at your 10% level, 2 puts at your 20% level and so on if you want to keep going. If the stock pulls back you would get put the shares. If you don’t want all the shares you could sell the extra shares and just keep the number of shares you would normally have bought at these levels. You of course have to be sure you aren’t over leveraging your account, and understand that if the company goes to zero you are responsible for the full 100 shares per put you sold, but this is a strategy I use. If the stock never dips I keep my premium. Again this is probably for the more advanced traders with larger account sizes. But it’s a great way to dollar cost average, and in bull markets this can be a good way to collect premium without having to own the shares outright.
I believe pyramiding is a strategy everyone should consider for part of their portfolio and trading plan. So many traders and investors wait for the ‘bottom’ to buy, only realize there can't be a bottom until we've already bounced so it’s too late. Don't be afraid to pyramid into companies you like! Have a stop, or protective puts. We'll cover hedging, covered calls, profit targets in upcoming articles.
At GKT, we help you build that plan. We might be all about those 'math-based' options, but we know there's more than one way to be profitable and to grow a portfolio. And sometimes, the simplest strategies, like pyramiding make all the difference in your trading journey.
If you have any questions about this strategy or want to learn more about trading in general, feel free to join our free GKT discord community. Let's continue to learn and grow together! Until next time, Happy Trading, Good Kids!
As a reminder, this is not trading advice, I am not a financial advisor nor am I recommending you setup or trade the previous examples.