As expected, my post last week about how I made 54 times my risk on a single trade idea sparked a lot of interest including several questions. The number one question I received about that trade was how I knew to pyramid rather than settle for a simple 4R profit.
To clarify, I knew my strategy going into the initial trade was to add to the position, however I did not know that the market would unfold the way it did. Nobody can ever truly know what the market will or will not do.
Another common question I received was why I decided to use the daily time frame rather than something like the 4 hour time frame.
These are both great questions that deserve further attention, which is why I decided to dedicate today’s post to answering both questions in detail.
In this lesson we will take a look at two pyramided trades, one on the 4 hour chart and one on the daily chart. I will explain the two factors that played into why I chose the time frames I did as well as what to look for before you commit to adding to a position.
We will also dive into what is arguably the most challenging aspect of pyramiding – differentiating between a trade idea that is a sprint versus one that is a marathon. In other words, knowing when a position is worth adding to versus one that should be traded with a single position.
The most important thing with a subject like this is to keep an open mind. Many traders fall into the trap of believing that they should always settle for 2R on every trade, because “profit is profit”, they say.
While that can be advantageous to build confidence, especially for a new Forex trader, the real money is made once you learn how to pyramid.
As Jack Schwager once said…
If you don’t stay with your winners, you are not going to be able to pay for the losers
Truer words have never been spoken.
Have you ever heard the saying, “a picture is worth a thousand words”?
It refers to the idea that a picture is much more telling than a simple description; that a complex idea can be conveyed with a single picture.
If that is true, then the big picture is worth 100,000 words.
Even when trading a higher time frame, there is always a larger price structure at play that may not be immediately apparent. A great example was the eighteen-month head and shoulders pattern that formed on NZDJPY between 2014 and 2015.
That pattern was not obvious even to those who were trading the daily time frame. It required zooming out on the weekly chart to see the larger pattern that was unfolding.
Why is this important?
It’s important because it should always be the very first step in identifying a favorable pyramiding opportunity.
One mistake I see many Forex traders make is to assume that they can pyramid any trade idea as long as the initial setup is favorable. In other words, they look for the trade setup first and the bigger picture second.
This is the opposite of what you should be doing.
The very first thing you want to do is to identify the larger price structure on your chart. In fact you should do this regardless of whether or not you intend to pyramid. Otherwise you will quickly find yourself trading in a silo, thinking that the 4 hour price action on a chart is with a bull trend when in fact it’s a mere correction inside of a larger bearish trend.
Another reason to identify the bigger picture first is that it helps to prevent your mind from playing tricks on you.
Let me explain…
When you put on a position first and look for the larger opportunity second, it causes your mind to begin seeing what it wants to see rather than seeing what is actually happening.
It makes you blind to all of the technical reasons as to why the trade idea may not play out and instead convinces you that everything is in place for a favorable opportunity to pyramid.
Obviously we all want to be able to hop into a trade and see the market take off for 1,000 pips in the intended direction.
But it isn’t that easy. You and I both know this.
However your mind, being the opportunistic engine that it is, wants to see a huge profit in your future. So it begins to automatically ignore some of the more obvious flaws that would prevent that huge profit from materializing.
By identifying the big picture first you avoid that trap altogether. This is because you have not yet risked any capital. And if there is no capital at risk, your mind is less likely to lead you down a path of emotional decision making.
So at this point we know that identifying the “big picture” must come first. That means that the second step is drilling down to the daily chart or 4 hour chart to watch for a favorable setup to materialize.
But before we talk about time frames, there are a few other factors that need to be considered before you should commit to pyramiding.
So far you have learned that finding a good candidate for pyramiding starts with the bigger picture. But what other factors need to be considered before you turn up the heat? Or as George Soros would say, “go for the jugular”.
There are in fact three other factors in addition to the bigger picture as described above.
For anything and everything you do in the Forex market, it must be inline with your defined style of trading. That means it has to fit your personality.
Some Forex traders are not comfortable adding to a position and would rather aim for a simple swing trade every time, and that’s okay.
Personally, I love pyramiding. It’s this style of trading that contributes to the majority of my profits these days. It’s also why I preach that your win rate is not all that important, at least not in the way most Forex “gurus” would have you believe.
But it all comes down to you and your preferred style of trading.
Don’t have a style yet?
No worries. That’s what demo accounts are for. Anyone pursuing a new endeavor in life has to start somewhere and Forex trading is no exception.
In order to successfully pyramid, you must have obvious support or resistance levels outlined. Otherwise you will not be able to be as precise as you need to be on your second, third and fourth entries.
How obvious should these levels be, you ask?
Obvious enough that you don’t have to send out a search party to find them. They should jump out at you within the first 30 seconds of analyzing the chart. Because if they are that obvious to you, they will likely be that obvious to the rest of the market as well.
I love trading technical patterns, but I also love trading with the momentum. Combine the two and you have a winning combination.
While it may appear that these are counter-trend, they are in fact with the momentum at the time of the breakout. Remember, momentum is never static.
It goes without saying then that momentum is a key ingredient for a successful pyramid, however patterns offer something that momentum cannot…
One great advantage to using technical patterns when pyramiding is that you can use the pattern’s measured objective as a final target. So if you have a measured objective of 1,000 pips, you can then use the obvious support or resistance levels along the way to add to your position.
Let’s take a look at an example…
Notice that the measured objective in this case was 1,000 pips from the break of the neckline. Knowing this adds conviction to the idea that a larger target is realistic, which in turn gives you confidence when it comes to adding to the position along the way.
The fact that it was such a large distance also allows for plenty of opportunities to add additional positions to the trade idea.
Now that you have a good idea of what is required to pyramid successfully, let’s take a look at two examples where identifying the larger pattern first ended up being extremely profitable.
First up is the head and shoulders pattern that formed on NZDJPY. As previously mentioned, the first thing I did was to identify the larger pattern that was unfolding.
Once I had this reversal pattern identified, it was simply a matter of waiting for it to trigger a favorable selling opportunity on the daily chart.
The chart below shows the trade setup that formed on the daily time frame.
Shortly after NZDJPY broke below the neckline, it formed a bearish rejection candle on a retest of the level as new resistance. Now I had a favorable trade setup and a valid reason to add to the position in order to increase the profit potential.
To see the NZDJPY trade above from start to finish, click here.
Another opportunity to pyramid came along on AUDJPY. Unlike the NZDJPY trade above, this one set up on the 4 hour chart. We can therefore call this more of a “sprint”, whereas the NZDJPY trade was a “marathon” as it took several months to play out.
The chart below shows the false break that kicked things off. This was the catalyst for what would eventually turn into a selling opportunity.
One thing I teach inside the Daily Price Action member’s community is that a false break in one direction often leads to a reversal. So as soon as the pair closed back below the trend line, I was on the hunt for a selling opportunity.
The very next candle produced such an opportunity in the form of a bearish rejection bar. This was my trigger to enter the market.
While I did not have a technical pattern to trade per se, I did have the bearish momentum in my favor. I also had a sixteen-month level as a target that was a good distance away, which gave me the confidence needed to start adding to this position.
To see the entire case study on the AUDJPY trade above, click here.
I want to wrap things up with the second most common question I received with regard to my previous post about how I traded the NZDJPY head and shoulders pattern.
There are two reasons why I chose to trade the daily time frame in that instance and not the 4 hour time frame.
The first reason above is self-explanatory. The initial setup was a bearish pin bar on the daily time frame, so naturally I was inclined to manage that position on the daily chart.
The second reason is a bit less obvious but just as logical. Because the head and shoulders pattern had taken eighteen months to form and the measured objective was 1,000 pips away, I knew it would likely be several months before the objective would be realized.
For that reason, I decided to manage the trade on the daily time frame as the 4 hour would have been far too granular for a trade that would span several months.
To summarize then, we can say that it all comes down to the time frame where the initial setup forms as well as the size of the price structure that is being traded as the “big picture idea”.
I hope this lesson has helped clear up any questions you may have had regarding when and how to pyramid effectively in the Forex market.
Below is a quick summary of some of the more important points from today’s lesson.
The most important consideration, above all else, is one that we did not discuss in this lesson but is certainly covered in the first lesson on pyramiding – never risk more than your trading plan allows on any single position and always use the same position size for each entry.
Follow those two rules and practice the principles discussed in this lesson and you will begin to see how pyramiding can have a hugely positive impact on your profit curve.
Do you have a better understanding of when and how to pyramid having read this lesson?
Is there anything you want to know that I didn’t cover?
Leave your question or comment below.