Averaging Up (Pyramiding)
Averaging up is just the opposite from averaging down. As the trade goes in our favor we keep adding positions. This technique is rarely used by traders, but one that can lead to profitability over time.
This technique is rarely used because acts against human natural reasoning to “lock some profits”. This natural tendency keeps us from gaining further profitability over our trading careers.
We need to make some things clear, once we are in a trade, and the trade goes in our favor it has a higher probability of success. If it goes against us right away then it has a higher probability of failure. If we add positions to an already losing trade, we have a higher probability of losing more; on the other hand, if we add more positions to an already winning trade then we have a higher probability of winning more. Makes sense doesn’t it.
Don’t get us wrong though, probabilities are just probabilities not certainties. It does not mean that if a trade is already winning it is going to win. It means that most of the time, when a trade starts in our favor we will win that trade.
Averaging up works as follows:
Our trader decides to go long USD/CHF at 1.2800. As the market reaches 1.2820 he or she adds another lot. At this moment our trader is averaging 1.2810, closer to the current price with a larger trading size. As the market hits 1.2845 our trader adds one more lot. As this point our trader averages 1.2822 and has a trade size of $300,000.
As well as averaging down, when averaging up we should have a well developed plan, otherwise we could end up with a very large position which is difficult to handle.
It is recommended to add progressively smaller long positions if our trade goes in the intended direction. For instance, our trader goes long two lots on USD/JPY. As the currency pair keeps going in his or her favor and breaks an important resistance level she or he decides to add a $120,000 unit size trade, if the USD/JPY keeps going up and breaks another resistance level she or he adds an $80,000 position. By doing this, our trader is making sure the market is trending before he or she trades the entire position.
In addition, increasing our trading size at higher prices will also increase our average entry price exposing you to a potential loss even during a normal market correction. This is the reason we recommend adding smaller positions as the market goes our way.
Adding positions randomly will definitely have disastrous effects on your trading account, and as with all Risk Management you must have a well developed plan. We cannot stress this enough and spend a lot of time in our live sessions helping our students develop this.
Averaging up does not violate the principles of “the trend is your friend” and “Let your profits run and keep your losses short”. In fact as you can see, it follows them.