Income Tax Rates

We've all heard the age old adage, cut your losses short, and let your profits ride. Yet the vast majority of traders don't use this concept to its fullest. The proper application of this single, key piece of advice can be the difference between showing a profit at the end of the month, and showing a loss. This method is known as pyramiding your profits.

Risk management is one of the most crucial elements of your trading system. Badly managed risk will lead to eventual losses, while well managed risk will lead to profits. A basic principle of speculation is that no more then 5% of your portfolio should be at risk during any trade. On a $50000 portfolio, thats $2500 at risk. This does not mean that you cant invest more then $2500 into a given trade, but it does mean that when setting a stop loss, you need to decide on position sizing accordingly.

So if a company is trading at $20 per share, and our stop loss is at $17.50, we can lose $2.50 per share by buying. If were willing to lose no more then $2500, then $2500/$2.50 = 1000 shares. So we should purchase 1000 shares for this trade.

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.

If it gets stopped out at 21, then you made gains of $1000 on the shares bought at 20, but you lost $3450 on the shares bought at 22.50, for a total loss of 2450, which is approximately how much you were risking on this trade. If it then continues to go up to $25/share, then you made $5000 on the shares bought at 20, and another $5750 on the shares you bought at 22.50, giving you a total gain of $10750, while only putting 2500 at risk. By adding shares, or pyramiding your profits, you substantially increased the potential reward of the trade, while maintaining a safe level of risk, and by cutting your losses short, and letting your profits run, your ability to profitably trade the markets will be greatly enhanced.

This strategy is useful both for long term investors, and for shorter term traders. Long term investors can use this to scale into upwards trending stocks to safely generate massive profits, while shorter term investors can use this strategy to minimize risk, while maximizing their overall gains.

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 most successful traders in the market aren't the ones who are right on 80% of their trades. Many of the most successful aren't right on 50% of their trades. A few of them aren't even breaking 30 or 40%. What separates the best from the rest isnt how often their right, but how much they make when they're right compared to how much they lose when they're wrong. By pyramiding your profits, you'll make massive gains, and small losses, which is a key to becoming a successful trader.