Investment accounts of most pyramid investors have finished this year with large draw-downs. Last four months were especially brutal. In such circumstances, it is hard to claim success or at least, the success is far from obvious.

Considering our emotions and sentiment about dollar valuation of our accounts, there is little room for celebration. We feel as prisoners in investment gulag. Few have remained with hope about ever being released from the gulag. However, Pyramid Investing is not about letting your emotions govern market actions. It is about proper risk capital allocation and robotical execution on a plan.

Even though Gold had 11th up year in a row and intra-year peak of 35%, Silver was smashed few times and eventually finished down. Expectations would be that account draw-downs were small or nonexistent. However, many pyramid investors had great deal of portfolio in different junior mining companies, explorers or various resource companies for that matter. The whole sector was literally obliterated in 2011 that made the gulag theme prominent. Resource equities fared significantly worse than actual resources they were involved with. Beating continued throughout the year and little chance was given for accounts to recover. Constant selling pressure was relentless. Just take Uranium sector for example after tsunami in Japan.

Irrespective of account draw-downs, pyramid investors need to focus on acquiring quality assets at favorable prices and acknowledge that there is something far more important than net liquidation value of investment accounts.

Gold is wealth, wealth is Gold

Here’s a simple question: What is WEALTH?

Simple answer: GOLD is wealth!

Of course, by Gold I assume Silver too. And energy (Oil, Natural Gas, Uranium…) and food (Wheat, Corn…). Or perhaps even all commodities (real stuff).

Once you know what wealth is, you also need to know: How is wealth MEASURED?

Few know correct answer to this question. And yet having clear understanding of this concept is absolutely critical:

Gold, as wealth, is NOT measured or expressed by its dollar valuation. Value of Gold is measured by scale! An ounce of Gold always has the same value irrespective of its price expressed in dollars, euros or whatever other currency. Wealth is in weight!

I would also venture to say that even value of your cash should be expressed in terms of ounces. Weight should be your base currency. In the world of relative values, you need a reference point to measure real and absolute values.

Number of ounces you have represents how much wealth you have. Grasping this concept is foundation of wealth building which assumes increasing number of ounces in possession. Increased number of dollars only comes as a consequence of increase in Gold weight and it should never be your primary objective.

Back to our performance in 2011: Even though dollar valuation of investment accounts is lower, accumulation of equities at significantly discounted prices as well as additional ounces acquired on price weakness result in greater wealth. Profits created by pyramiding in and out of positions are ultimately converted into Gold and that is all that matters. In light of such mindset, pyramid investors can claim that 2011 has been a successful investment year!

Just for the record, here is a snapshot of futures performance for year 2011 by FinViz:

1-Year Performance of Futures (during 2011)

Recommendations for 2012

There are many reasons for 2012 to play out as a year of crises, as a year of continued crises and as a year of intensified crises. There is nothing linear about crisis and disturbances are unavoidable part of it. While disturbances and instability are more appropriate terminology for engineering systems, in everyday world of investing, economy and politics, surprises are the equivalent.

In order to deal with surprises in as safe manner as possible, your 2012 investing approach should respect the following recommendations:

1. Do not use ANY leverage in your account. Whether large or small, temporary or permanent, planned or accidental, leverage will always get you! 2012 will be a year in which you definitely don’t want to mess with taking chances with leverage.
2. Maintain high levels of cash. Even though this may look absurd in an environment of heightened risks of cash devaluation, it is more important not to get into a situation where you would need to tap into your Gold stash for whatever reason. This is of course under assumption that you DO have plenty of cash to begin with.
3. Increase percentage of your net worth that is kept outside the system. Since risks of losing what you have in the system are elevated, it is only prudent to get some of what you have while you still have it and while you are still able to get it out of the system.
4. Reduce trading. First, reduce the percentage of your net worth that is dedicated to trading (this of course includes pyramiding). Second, increase steps and ranges of your pyramids which complies with expectations of mind-boggling volatility.
5. Keep more of your assets as a core. Keep that core extremely tight and far from your own reach as you will undoubtedly be exposed to many pressures to sell it. Far from your reach means, for example, to take possession of share certificates for your core positions. Such move is also in accordance with recommendation #3 and it helps fight against those who borrow your shares to sell them short.
6. Keep your emotional stability. Never be tempted to price chase anything under any circumstances, no matter how much things look desperate or are running away. Wait for price to come to you instead.

I wish you all happy, healthy and prosperous New Year 2012!

Another amazing year for pyramid investors has been brought to a close. Consistency of creating profits continued in 2010 in accordance to our expectations. The amount of profits that was created was certainly helped by strong precious metals market. Thus not only Pyramid Investing brought many profits and no losses, but the sheer volume of profits was much greater than perhaps even we anticipated! Pyramid Investing was able to beat the broad market (consistently) with ease, which in general is the most daunting of tasks for any other investing concept.

I would like to point out that there is no doubt in my mind that Pyramid Investing profit creation consistency will ever stop. Twenty or thirty years from now, I am sure I will have repeated the same story many times over. To those of you who still do not have trust or expect some multi-decade track record before committing capital per Pyramid Investing concept, I can only tell: You will be wasting precious time waiting for your expected confirmation or proof that it works, time that you will never have back to relive and invest per Pyramid Investing concept.

Due to applying Pyramid Investing in 2010, we have realized profits by trading pyramids. We are also sitting on unrealized profits on core positions acquired in a pyramidal way. Current financial state of our investing accounts is much stronger than it used to be when we started Pyramid Investing. Another important aspect is that our emotional state is much stronger as well. Now we can withstand much larger hit on our accounts while at the same time acquiring more assets at lower prices. That translates into even greater reduction of risk in our investing approach. Virtuous cycle has been initiated! Everything points to even more successful year(s) ahead of us.

Volatility to increase

I have to admit that I anticipated much higher volatility in 2010. Although volatility did pick up somewhat, it was far from levels that would concern even ordinary investors who are normally afraid of volatility. As usual, I was too early in my expectations. But that doesn’t change anything since fundamentals for tremendous volatility are still existent and actually getting stronger. I may be too early for 2011 again, but I doubt. I strongly recommend buckling up and getting those pyramids ready to fire on all cylinders in 2011!

Perhaps it may be inconvenient to get into a position months ahead of significant move and spend some time in trenches (think Natural Gas for example). But there is nothing wrong about being ready ahead of time. And yet, majority of investors wait until the last moment to prepare. As a matter of fact, they wait for the move to occur as a sign of confirmation of their expectations. I believe that moves in New Year 2011 are going to be so sudden and violent that anyone who has a tendency of waiting will be left in the dust. They will simply remain stunned with no positions whatsoever. Others will price chase in terror and will be subject to multiple whipsaws to their obliteration.

There will only be one trading strategy to successfully survive the upcoming volatility and that is Pyramid Investing. Those who do not embrace Pyramid Investing as a trading are recommended not to trade at all as markets will become untradeable. They should only acquire core positions (ASAP) and hold them (lock them, bury them) throughout the period of next several years at a minimum.

Trading predictions for 2011

Even though majority of prospects for 2011 are outright scary, I believe pyramid investors will come out on the other side unscathed – at least financially. During stable times, Pyramid Investing is supposed to grow wealth in a significant manner. During times of crisis and turmoil, Pyramid Investing preserves real wealth which is also great achievement although on a relative basis.

I do not want to venture into predicting what is going and what is not going to happen in 2011. Pyramid Investing is based on responding to whatever DOES happen. Thus in the spirit of Pyramid Investing, I will give the following trading predictions, considering Gold is around $1,400 now:

• If gold goes to $1,500 I will sell some
• If gold goes to $1,600 I will sell more
• If gold goes to $1,700 I will sell even more…

• If gold goes to $1,300 I will buy some
• If gold goes to $1,200 I will buy more
• If gold goes to $1,100 I will buy even more…

You get the point. What I DO predict is my own actions. So far I have 100% track record of being right on my predictions about my actions!

Core positions

I think the time is right to stress the importance of acquiring and holding core positions in upcoming years. And not just any core positions but strictly precious metals and resource/mining stocks. Core positions are treated differently than trading pyramids. They are strongly held for the whole duration of the bull market. One should never attempt to sell core positions with intent of getting them cheaper at a later time. That strategy WILL NOT work in 2011 and arguably for many years thereafter. Those who attempt to time the market with their core positions will be punished with time out!

Due to acceleration and increased steepness in precious metals price rise, core positions should take significant weighting within portfolio. As opposed to stable times when trading pyramids tend to produce considerable returns in markets that more-less do not trend but move within narrow ranges during prolonged periods of time, times ahead will likely be characterized as times when core positions will have brought the bulk of returns (wealth).

Of course, since no one can predict the future with certainty, it is advised to apply both trading per Pyramid Investing concept as well as holding core positions acquired on weakness in a pyramidal way. I wholeheartedly recommend embracing Pyramid Investing concept for the sake of financial prosperity and survival in the markets during difficult times ahead of us.

I wish you all happy, healthy and prosperous New Year 2011!

Great part of our understanding and impressions about market is subject to question. We may not necessarily know what we think we know. What we think we know may also not be true. Others can tamper with our knowledge and make up our minds for us. Sophisticated methods of creating or altering our knowledge have been used for centuries for the benefit of those who applied those methods. We are controlled in everything we think or do whether we are aware of that or not.

Market players

If you take the highest possible view of the market, you will basically see only two major groups: Institutional players and Commercial players. All others are just small fish, a noise in the system.

Institutional players are also known as FUNDS. These include all kinds of Mutual Funds, Hedge Funds, Pension Plans and other assets/asset management institutions. They are also called non-commercials or Managed Money.

Commercial players are also known as BANKS. These mostly include large investment banks. Sometimes they are referred to as Producer/Merchant/Processor/User group.

Other players like small retail players or PUBLIC are usually too small to make any difference. However, combined as a group, they have very important role as we will see below. Ordinary investors, who are members of team Public, incorrectly comprehend the picture of market players. They tend to think “Us” vs “Them”, “Us” being Public and “Them” being Institutional players. They either do not see Commercial players or at best do not understand who they are and what their role is. Nevertheless, they hate them.

Market game

Market can be thought of as one continuous game or a sport discipline where two teams try to outprofit each other. However, market is not an ordinary game – in this game winner is determined from the very start!

The amazing fact is not how one team wins all the time. It is astonishing how the other team has such enormous desire to play even when it is destined to lose. Even more astonishing is where the losing team comes up with all the capital it incessantly loses throughout the game.

You may be wondering which team is the winner? The sole fact that you might be asking this question actually explains a lot of things. At least it confirms that it’s not obvious who is winning all the time. Of course, the winning team tries not only to hide that it wins all the time, but it tries even harder to hide the fact that it is predestined to win to begin with!

What kind of a game it would be if you knew the winner before the game even started? If you knew that one team wins all the time and takes all the profits away, wouldn’t you be tempted to try to do the same? At the same time, the other team would look like a bunch of idiots, wouldn’t it? And when losing team figures it loses all the time, then short of other incentives, why in the world would they want to play anyway?!

Wealth transfer flow

Losing team is NOT bunch of idiots. The key word here is “other incentives”. The thing is, losing team doesn’t lose its own money! Thus, from their perspective, everything boils down to “other incentives” – trading commissions, management fees, bonuses etc.

So the answer to who is who in the big market game is: Eternal loser is Institutional player. That leaves Commercial player as eternal winner.

Basically, the whole market was invented by Mr. Commercial player. Of course, he setup the whole system and created the rules so he wins all the time. In order to close the loop, he needed another player and a source of capital to suck on. Public turned out to be a perfect target for a sucker: they work hard, they are told to invest and they do not have much brain to see what’s going on. So the public was sold a dream, Institutional player was made into a player designed to conduct wealth transfer and Commercial player collected all the wealth.

The Figure below shows unidirectional flow of capital. The wealth generated by Public gets invested with Institutional player who loses it all to Commercial player. Actually, Institutional player gets to keep a chunk of capital in the process of wealth transfer, just enough to keep itself afloat and happy to perpetually facilitate this transfer. Commercial player is a wealth magnet, operating from a shadow and piling up his wealth mainly in the form of gold. Public is oblivious to the whole situation, incessantly being fed by media and news created by Mr. Commercial player. Army of financial advisors, market analysts, respected economists, rating agencies and other “leaders” are employed by Mr. Commercial player to brain wash the Public and keep their focus away from reality so they can commit their wealth to the greatest wealth transfer machine ever invented.

Wealth Transfer Flow - From Public to Funds to Banks (and Pyramid Investors)

I hope you are not surprised with this wealth transfer revelation. If you are, then you need to start investing for your own benefit. It begins with realizing your position in the figure above (hint: Public) and accepting the fact of unidirectional flow of your investment capital. Next step is shifting your position from the source of capital to recipient of profits.

Position of pyramid investors

Even though pyramid investors rise from team Public, they nevertheless achieve to position themselves as a recipient of wealth. They refuse to buy the dream attempted to be sold to them. They chose to make their dream come true on their own by applying the only investment concept that works: Buy weakness, sell strength.

Pyramid investors refuse to let the Institutional player take their money as a means of supposedly achieving their dream for them. They decide to play on the same side as Mr. Commercial player. They understand they don’t need to be in love with Mr. Commercial player, but they do adopt his formula of success in the market. Market is his playground and his business where he is the undisputable ruler who mastered the philosophy of trading and profit making. Pyramid investors don’t need to reinvent anything, but only to apply what Commercials have been doing in the market for centuries already. Not having nearly the amount of capital as Commercial players, pyramid investors nevertheless apply the same approach with, of course, the same outcome only on a smaller scale.

So the saying I remember from Daffy Duck cartoon: “If you can’t beat them, join them”, is more than applicable in this scenario. There is actually no need to beat the Commercials as long as you are making profits in a manner they do. Ironically, the amount of suckers in the market will always be just right to provide abundance of profits for rest of us (pyramid investors and Commercials).

In the next article about COT reports, I will try to substantiate some of the claims I am making in this article.

I feel compelled to share my personal Pyramid Investing portfolio behavior throughout roughly last eight months. Those of you who don’t mind putting your heads into charts and numbers I am about to show, will realize what a powerful concept Pyramid Investing is. I can come up with number of different ways to present actual Pyramid Investing concept performance, and certainly this is one of them. But more so, I think this particular example will go even further in showing you an actual high level picture of one portfolio in action, portfolio that is based on Pyramid Investing. Hopefully, it will also help you connect some dots to get better understanding of pyramid application rules and results in practice. It is also to show you what is realistic and what pyramid investors can expect in return from their pyramids in action.

As I described in the article “Buy Weakness, Sell Strength”, such action is one of the most important ingredients of Pyramid Investing. You can call it Pyramid Investing or whatever you feel like calling it, but as long as you are buying every weakness and selling every strength in a pyramidal way, you stand to make a fortune. You should also try not paying much attention to absolute prices your trades revolve around. Absolute prices are meaningless in terms of making consistent profits and only serve to inhibit your otherwise profitable actions. One of the truths about making consistent profits is: “If you sell at certain price, be prepared to buy again at a higher price!” This may sound totally out of logic, but that may also be a reason why many investors refuse to understand this principle. Lack of such understanding contributes to eventual myriad of losses.

My portfolio consists of number of different pyramids. They are shaped differently, and they capture various oscillations by their design. However, they all work in tandem and behave like one giant pyramid – a pyramid that buys weakness and sells strength. Therefore, observing my whole portfolio in action is very close to observing a single pyramid and vice versa.

Gold volatility

As a starting point, let’s observe gold bullion price chart during the period between late June 2009 and late February 2010. The chart is shown in Figure 1 (courtesy of StockCharts.com).

Fig 1. Gold bullion daily price chart with trends

Fact is that price of gold was higher at the end of the period than what it used to be at the beginning. It could have been the other way around, but that is not the point. It is important to acknowledge that the price didn’t move in a straight line from $913.20 to $1,127.30. The price actually zigzagged.

Volatility during the period observed wasn’t extreme. Nevertheless, many price uptrends and downtrends can be identified. The chart shows daily prices of gold bullion. Overlaid is a ZigZag line based on at least 3.5% change in price that helps us identify trends. For every trend identified, one can observe even smaller trends. But we are not going to bother with those micro trends and we will assume price moved in a straight line between high and low points identified by ZigZag segments. In other words, without significant loss of accuracy, we can replace the actual daily gold price chart with our ZigZag line.

Bottom of the chart shows S&P 500 index moves for reference and comparison to gold price moves.

Figures 2 and 3 show left and right portion of the same period in a slightly different way. Some additional indicators (simple moving averages and Keltner channel) are given as a technical reference.

Fig 2. Alternative gold bullion daily chart (left portion)

Fig 3. Alternative gold bullion daily chart (right portion)

Portfolio breathing

Majority of portfolio pyramids are based on various gold instruments that directly or indirectly follow price moves of gold bullion. This is not to say that portfolio based on any other instrument would experience much different behavior. There are many reasons why gold is the chosen one but I wouldn’t want to discuss that at this time. Your focus should be on volatility, perpetual moves in price and of course buying weakness and selling strength.

Figure 4 shows a table with some very interesting data. The most significant trend highs and lows have been selected along with the date they occurred on. Price of gold column lists corresponding gold trading price extremes so the spreadsheet can do some calculations for us. Thus for each uptrend, percentual change in gold price is calculated and shown in black. Likewise, each downtrend percentual change in gold price is calculated and shown in red. The change column is supposed to give us a feel of how much gold price changed in percents for each trend we identified and approximated with a straight move in price.

Fig 4. Pyramid Investing portfolio table with trend related percentual data

I would like to bring to your attention one very strong bullish move in gold price: From $905.10 to $1,226.40 gold moved up with only few shallow weaknesses. That was more than $300 move in gold price or more than 33% move in percentage terms! Basically, this four-month move itself represented the entire price of gold just 10 years ago when this gold bull market begun. Such strength must be sold.

Thus the price of gold went up and down and up and down… It zigzagged during the period we observe right now. It zigzagged pretty much within every period before, just like it will zigzag in every period to come. Volatility is here to stay and it will never become obsolete. As a matter of fact, those well informed mention that volatility is about to skyrocket!

So the question is: How did the Pyramid Investing portfolio behave during these price oscillations? And the answer is – Portfolio responded to price of gold by breathing!

For each downtrend when price expressed weakness, portfolio inhaled. Likewise for each uptrend when price expressed strength, portfolio exhaled and generated profits. This is a process just like we all breathe every day. Sometimes we sleep and we breathe slowly. Sometimes we run and we breathe quickly and deeply. Although we choose whether we sleep or run, Pyramid Investing portfolio responds to price moves that are beyond our control. “Breathing” may not be so regular. Portfolio action is not influenced by time. Only price determines actions and the more volatile it is, more action is created and consequently more profits are generated.

Portfolio inhaling is equivalent to buying and exhaling is equivalent to selling. BOT/SLD column in the table shows how much buying and selling occurred during downtrends and uptrends respectively. Data is given on a percentage basis with the basis being total cost of all pyramids comprising the portfolio.

Last column shows the amounts of profit generated during each uptrend and downtrend move. Profits are expressed in percentages based again on the total cost of all pyramids comprising the portfolio. Bold numbers correspond to profits generated during uptrends, while smaller font is used for profits generated during downtrends.

ZigZag chart with the data

Let’s combine the table from Figure 4 with ZigZag chart from Figure 1. Now we have all relevant information shown in one place, Figure 5. (Please open Figure 5 in new tab or window so you can read all the details)

Fig 5. ZigZag chart with percentual data callouts

As you can see, each trend line is accompanied with corresponding low and high price of gold as well as callout that contains relevant percentual information. It should be easy for you to get a good feel of portfolio actions that accompanied each trend and draw some conclusions on your own.

Looking at the entire eight-month period, it can be observed that there were exactly eight downtrends and exactly eight uptrends. In other words, there were eight distinct oscillations with an average of one oscillation per month. These numbers just happened to be round and divisible. Nevertheless, you should get an idea of frequency and magnitude of oscillations in gold bullion price.

Returns

If we go back to Figure 4 and look at the Total amount of profits achieved during an eight-month period, we see approximately 8%. In other words, the rate of profit generation is approximately 1% per month! Not only this is an amazing number, it is consistent. More-less we don’t even need to care where gold price goes – we simply respond to price variations in a pyramidal way and collect our 1% profit each and every month (on average). Some months the return may be ½%, but some other months may generate 2-3%. We cannot demand profits, but sure enough we’ll take all the profits market has to offer.

What is expected annual return? 1% a month once annualized becomes 12% a year. Talking about consistency, this means 12% EVERY year. Some will argue that stock market can occasionally produce 30% a year. That is true. But notice the word occasionally. That same stock market occasionally loses 30% a year as well, which is extremely unlikely in Pyramid Investing. If you take last century of returns in stock market, you may get something like 8-10% per year on average. Not only that Pyramid Investing beats the market in general since it produces higher returns, but the consistency is what makes significant difference. We will address consistency of returns in more detailed manner at some later point in time.

Let’s go back to the original eight-month chart shown in Figure 1. Price at the end of eight-month period was ~24% higher. Ordinary amateur investors can argue that if one simply bought and held the position throughout the entire period, the return would have been three times larger than what was achieved through Pyramid Investing portfolio. Unfortunately, such thinking is flawed. What would happen if price went down during the same time frame? How can one know exactly when to buy and exactly when to sell to make this return on a consistent basis? The answers to these questions are exactly what makes majority of market players actual losers.

Ordinary amateur investors tend to focus on possibility of achieving higher returns under illusion of being capable of making perfect timing calls. They neglect simple rules of mathematical probability. If one has, let’s say 10% chance of making 24% return for a given eight-month period by applying buy and hold concept (that is plopping the entire capital at the beginning and selling the whole position at the end), it boils down to making only 2.4% actual return on average by performing large number of such plays. More likely, such financially suicidal plays would result in above mentioned “investor” being wiped out from the investing arena.

At the same time, pyramid investor would accumulate “only” 8% return on every such eight-month period, with a chance of doing so close to 100% while taking microscopic risks along the way.

Thus to reiterate, Pyramid Investing returns are greatly independent of price move’s direction. Pyramid Investing returns don’t rely on timing. By virtue of eliminating these two obstacles, actual returns are decoupled from market direction and biased investor’s timing urges. Returns are consistent. Pick your timeframe, pick your investing instrument and pick your market. Chances are, with Pyramid Investing concept you are going to end up as winner no matter what.

Risk

Another aspect I would like to mention briefly is risk. How risky does Pyramid Investing concept appear to you when you observe the chart in Figure 5?

First, what IS risk? What do we all afraid of when we commit our capital to investing? Of course, we afraid we may lose it or lose a good chunk of it. So the risk is likelihood of us losing money when we invest.

In Pyramid Investing we start from 100% cash in our accounts. We plan to have enough cash to be able to keep buying our investment of choice in a pyramidal way all the way to zero. Short of that investment going off the board, the only thing that happens when the price goes down is that more cash gets invested. That’s all. Nothing gets lost. The price goes down, cash buys us stocks. The price goes up, we sell and get our cash back plus profits.

What if gold is 50% down in five years? Buy it now and hold it and your account value will halve. Apply Pyramid Investing and book 12% annually or 60% for five years (cumulative, but not compounded return) – not only Pyramid Investing will lose no money, profits would actually exceed the percentage drop in gold price. In other words, there is no risk. Of course, there is risk that the rate of gold dropping exceeds expected rate of Pyramid Investing returns (most likely only temporarily). Even in such unlikely scenario pyramid investor would fare significantly better than ordinary buy-and-hold investor. Or even better, extend your period to 9 years – after that you won’t even care if gold went to zero! Above all, gold kept its value for 5,000 years. Chances are slim it will go off the board in next 9 years.

What if gold goes 50% up in five years? Then sky is the limit. Or better yet, think about gold going up 50% before the end of 2010 or 2011. This is just an outburst of my gold bullishness.

Bottom line, I don’t know and I may not care where the gold goes. But the risk of Pyramid Investing through gold is negligible, yet the rewards are fabulous.

Data skews – downtrend profits

I should mention an apparent anomaly that you may have wondered about. Namely, even during downtrends in gold price, some profits have been realized. How come?

There is no way I would sell any portion of any of my gold positions on weakness! I came up with at least three explanations to this apparent paradox.

• Not 100% gold

Although heavily weighted in gold, my portfolio has some oil components and other minor components that do not necessarily move in the same direction as gold. Thus while I am acquiring gold on weakness, other stuff may be experiencing strength and I may be realizing profits in those other instruments. That is one of the reasons profits are realized regardless of gold going up or down. However, it is noticeable that profits realized on gold strength far exceed profits realized on gold weakness.

• Gold short instruments

Intermittently I use some gold short instruments to boost my overall returns. Those are normally inverted short gold ETFs or ETNs that I employ only into the extreme strength in gold price. By their design, those instruments bring profits during downtrends in gold price. That is another reason of portfolio non-zero profits during gold price downward moves.

• Short-term up-moves

No trend propagates in straight line. Whatever length of a trend you analyze, you will always find some counter-trend moves within that trend. Duration of counter-trend moves is normally much shorter than the trend itself. But nevertheless, on occasion, those moves are strong enough to generate profits during otherwise downward trends. Especially, some of portfolio pyramids are based on highly volatile gold juniors that are also inherently leveraged to gold price moves. So this is one more reason profits get generated even while price of gold is mainly heading down.

Data skews – excessive buying on weakness

If you look at the gold price retracement that occurred after all time peak of $1,226.40 in early December 2009, you will notice another apparent anomaly – the amounts of buying appear to be excessive: 25% and especially 40%. The cause of these larger-than-expected buys lays in accumulation of core positions.

Core positions have not been addressed here yet. However, in terms of wealth creation and capturing large price moves, core positions play crucial role. By definition, core is a position that at the time it was acquired hasn’t been associated with a clear plan of when or at what price it will be sold. Although core is also acquired in pyramidal way on a price weakness, it does not belong to trading pyramids. Only certain instruments qualify for core positions and gold is definitely one of them. Core positions are always long and placed in various major markets. Sometimes they sit in portfolio for generations.

Just in case you wondered, roughly around gold $1,600 I may consider starting selling some of my core gold positions. Of course selling would be performed in a pyramidal way.

Treat portfolio as a sculpture

Pyramid Investing is a process of scaling into a position on weakness and scaling out of a position on strength. Portfolio based on Pyramid Investing tends to breathe in and out as the price goes down and up. Just as price doesn’t go from zero to infinity and back in short periods of time, Pyramid Investing portfolio doesn’t experience abrupt changes in its positions. Portfolio in Pyramid Investing is like a sculpture that is constantly to be tended to. Only small chips are taken away only to be glued back later. This process is smooth and slowly evolves in front of our eyes. The whole sculpture actually grows quite nicely in time.

Treat your Pyramid Investing portfolio as a precious sculpture. Be gentle, yet responsive. Take care not to break any limb of your sculpture, let alone cut its head off. If you do it, your sculpture will shatter and you’ll be sorry. Your pyramid sculpture is your financial life. Respect it in every sense of that word and you will live long and happily ever after.

So far, we have defined number of different terms used in Pyramid Investing: some price-related terms such as Top, Bottom and Step or amount-related terms such as Base and Increment. Values of these terms represent elementary measures of a pyramid. These terms as a group, that is combination of their values, uniquely define any arbitrary pyramid. In other words, we can say that any pyramid is fully determined by values of the following terms:

• Top
• Bottom
• Step
• Base and
• Increment

If the value of any one of these terms is missing, the pyramid is undetermined. The only “redundant” term in this group may be the Bottom and only because we assume bottom is zero unless specified differently.

Many times, we will refer to a specific pyramid and list the values of its Top, Step, Base and Increment. No matter how big the pyramid is or how many discrete levels it has, these four elementary measures are all we need to uniquely describe the pyramid in question. Elementary measures determine position and shape of a pyramid.

Derived measures

Beside elementary measures, we make use of other measures that are derived from elementary ones. The process of deriving actually involves some simple calculations. For example, the price at each Depth is derived from Top and Step. The formula to calculate Price (n) that corresponds to Depth n is:
Price (n) = Top − n × Step

Similarly, the amount of shares bought at certain Depth n is derived from Base and Increment:
Size (n) = Base + (n−1) × Increment

I would like to note that the last formula does not hold in general case since Size (n) is not uniquely defined for arbitrary Depth n due to dynamics of trading. However, for the sake of this article, we will assume that price descends in a straight line from top to the bottom. In such a case, the formula above holds true and we can freely make use of it.

We can further derive dollar value of Trade that occurs at Depth n, which is calculated from corresponding price and the amount of shares traded at that level:
Trade (n) = Price (n) × Size (n)
Trade (n) = [Top − n × Step] × [Base + (n−1) × Increment]

Even though these formulas involve some basic mathematics, their calculation is rather tedious if we attempt to do it on a piece of paper. However, with a help of any spreadsheet software, results for multiple levels can be obtained instantaneously.

Cost of a pyramid

Most frequently used derived term or measure is cost of a pyramid. Cost of a pyramid is sum of all trades across all pyramid levels. In simple terms, cost of a pyramid represents the amount of money we would need to buy the whole pyramid or the amount of dollars we would employ if the price of underlying stock went to zero. We sincerely hope that our underlying stock will never go to zero, but nevertheless the cost of a pyramid represents ultimate amount of money to be used for a given pyramid in the most extreme scenario.

In terms of risk, cost of a pyramid is the maximum amount of money we can possibly lose applying a given pyramid. It is always good that the risk is limited and easy to calculate. It may not be so easy to accept this risk but we certainly have a way to deal with it. Besides, who said that investing is risk-free endeavor anyway?

Cost of a pyramid is very important measure and we heavily rely on it in the process of Pyramid Investing planning. As I mentioned elsewhere, Pyramid Investing consists of meticulous planning and robotical (virtually emotion-free) execution of the plan. Cost of a pyramid is also unavoidably exploited in calculation of Pyramid Investing returns. We will address each of these issues separately. For now, it is important to understand how to calculate the cost for a given pyramid.

Example of pyramid cost calculation

So let’s assume that the pyramid we want to calculate the cost of is given by the following elementary measures:

• Top = $11
• Step = $2
• Base = 10sh
• Increment = 5sh

First, we need to calculate price for each pyramid Depth:
Price (n) = Top − n × Step

Price (1) = $11 − 1 × $2 = $9
Price (2) = $11 − 2 × $2 = $7
Price (3) = $11 − 3 × $2 = $5
Price (4) = $11 − 4 × $2 = $3
Price (5) = $11 − 5 × $2 = $1
Price (6) = $11 − 6 × $2 = −$1

In this process, we increase the Depth and calculate corresponding price. Although we say Bottom is zero, practically only non-zero and positive prices make sense. Therefore we repeat the process until we hit either zero or some negative price. We stop there and we do not include that last calculation. In our example, pyramid has five depths and actual Bottom is $1.

For the sake of accuracy, I would like to point out that, strictly looking, the unit for Top, Step and Price is $/sh (dollar per share). We use $ sign only for the reasons of simplicity.

Now, we calculate the amount of shares bought at each Depth n:
Size (n) = Base + (n−1) × Increment

Size (1) = 10 + (1−1) × 5 = 10sh
Size (2) = 10 + (2−1) × 5 = 15sh
Size (3) = 10 + (3−1) × 5 = 20sh
Size (4) = 10 + (4−1) × 5 = 25sh
Size (5) = 10 + (5−1) × 5 = 30sh

Then, we multiply price and amount of shares for each Depth n to obtain corresponding Trade dollar amount:
Trade (n) = Price (n) × Size (n)

Trade (1) = $9 × 10sh = $90
Trade (2) = $7 × 15sh = $105
Trade (3) = $5 × 20sh = $100
Trade (4) = $3 × 25sh = $75
Trade (5) = $1 × 30sh = $30

Finally, we sum up all trades to obtain the Cost of our pyramid:
Cost = ∑ Trade (n), where n = 1,…,N
Cost = Trade (1) + Trade (2) + Trade (3) + Trade (4) + Trade (5)

Cost = $90 + $105 + $100 + $75 + $30
Cost = $400

Therefore, the Cost of our pyramid is $400. If we change any of initial elementary measures, subsequent pyramid gets to be different and that may result in corresponding Cost to change. This is not to say that two different pyramids cannot have the same cost.

Cost is usually given

In practice, instead of calculating cost for a given pyramid, we usually have a cost that is given. Therefore, our task is to design a pyramid that fits the given cost. This is normally an iterative process. Besides trying to satisfy the given cost, we also strive to take care of other aspects of a pyramid at the same time. This process of designing a pyramid is also called shaping the pyramid. In future articles, we will dedicate considerable attention to the process of pyramid shaping. We will also address various criteria we want to satisfy (or at least make the trade off) during this process.

Talking about the cost of a pyramid, we can also say that some pyramids are “costlier” than others. Of course, pyramids that have larger cost are “more expensive”. This means that we need more investing capital to properly cover more expensive pyramids.

Pyramid in a spreadsheet form

Graphical representation of pyramids is good for initial understanding of terms and their relationships. However, practical use of pyramids involves more abstract representation that is also more suitable for our investing purposes. We normally turn to spreadsheets that also help us in number crunching activities. I extensively use Excel spreadsheets to help me in daily Pyramid Investing efforts.

The following figure shows the above-mentioned pyramid in a spreadsheet form:

Fig 1. Example of a Pyramid in a spreadsheet form

This is only a snapshot (screen capture) of a spreadsheet pyramid and therefore it is not interactive. Actual spreadsheet contains above-mentioned formulas in corresponding cells and is capable of calculating values based on given elementary measures of a pyramid. Cost of a pyramid is highlighted in yellow.

Earlier in this category, we introduced Basic Price Oscillation and defined exact actions that are to be performed along the price path. Price change that corresponds to the basic price oscillation spans exactly one price step. In other words, price starts from one discreet price level and falls one step lower to the next adjacent discreet level before it rises up again. We can say that price moves one step into the depth. While performing this oscillation, price never falls more than one step and thus the oscillation is considered basic.

Depth of deeper oscillation is two steps or more

Although basic price oscillation happens quite often in reality, it is only a special case of a deeper price oscillation where price experiences larger swing that spans two or more steps. Price drops deeper than within the basic price oscillation and moves two or more steps into the depth.

Please note that since price and the way it moves is out of our control, we can obtain the equivalent result by reducing the step size of the pyramid. Therefore, the same absolute price move can span more than one step if the step is smaller. Thus for the same price swing, instead of basic price oscillation, we may be acting according to deeper price oscillation.

Interesting fact about deeper price oscillation is that the rules of pyramidal trades kick in. Since price moves at least two steps in depth, then at least two buy trades occur. Similarly, at least two sell trades occur as the price moves back up. I would like to point out that we still haven’t defined the term offset and thus we have equal number of buy and sell trades for a given symmetrical price oscillation. When we introduce offset in selling, levels at which sells occur will shift accordingly.

Since there are two or more trades in each direction, they have certain relationship. Naturally, the relationship is pyramidal. Pyramidal trades imply ever increasing buy amounts as the price drops lower and ever increasing sell amounts as the price rises higher. An example of deeper price oscillation that spans four steps is shown in Figure 1.

Fig 1. Deeper Price Oscillation

We can observe that blue rectangle widths increase as we buy into larger weakness and red rectangle widths increase as we sell into larger strength. But, let’s break apart deeper price oscillation and look closer at each portion thereof.

Downward price movement (buying)

We have already mentioned earlier that in Pyramid Investing we exclusively buy price weakness. Considering the price is at the top when oscillation begins (depth = 0), price expresses ever larger weakness with each new discreet price level reached on the way down. The idea is to buy into weakness. Also as the price tanks, the size of price weakness relative to the top is getting larger. The larger the price weakness, the larger our commitment to buy the underlying stock. Buying weakness is always difficult and feeling of fear is usually in our way. However, buying weakness is the most proper action we can do. Courage of buying weakness is always handsomely rewarded.

Fig. 2. Downward price movement - Price decline

Figure 2 shows the down slope of deeper price oscillation. Blue rectangles represent buy trades. Width of each blue rectangle represents the amount of shares bought at corresponding discreet price level. Number of additional shares bought at each depth is shown next to the rectangle. Of course, the numbers shown here are just as an example and the actual amounts bought get determined by particular pyramid in use. Also, larger font size is used for larger amounts to visually emphasize importance of pyramidal buys. Rectangles are framed into a pyramid for clearer distinction and easier shape discrimination.

Price bottoming and turning direction

At some point that is unknown to us, price bottoms and turns around. It then proceeds in an upward direction. Take a look at the Figure 3 and observe some important details related to the price bottoming.

Fig. 3. Price bottoming and turning direction

As the price was moving down, we already made our last buy. Soon after, price bottomed. Turning point is only slightly lower then the price of our last buy and certainly less lower than the step size. Otherwise we would have bought the next lower discreet price level. Since price turned around, that level was never reached. We can pretty much say that we bought the exact bottom, especially when our pyramid applies small step size.

Price turned around and quickly reached discreet price level of our last buy. An important rule can be reiterated here: Trade at certain price level disqualifies that price level at least until next trade occurs at some other price level. This may sound complicated but it only means no action is performed at the level we already made purchase at. On the other hand, if we would to sell at this level, it would only mean zero profit and incurred trade commissions, which of course doesn’t make any sense for us to do.

Therefore, we patiently wait for the price to move one step higher. Again, no offset is used and thus one step higher is all the move price needs to make before we make a sell. That is our first sell. Please note that the amount of first sell is significantly smaller than the amount of last buy.

Upward price movement (selling)

After the price bottomed, it began ascending. We have already mentioned earlier that in Pyramid Investing we exclusively sell price strength. Considering the price was at the bottom, price expresses ever larger strength with each new discreet price level reached on the way up. The idea is to sell into strength. Also as the price soars, the size of price strength relative to the bottom is getting larger. The larger the price strength, the larger our determination to sell the underlying stock. Selling strength is always difficult and feeling of greed is usually in our way. However, selling strength is an important professional action that we have to undertake.

Fig. 4. Upward price movement - Price ascent

Figure 4 shows the up slope of deeper price oscillation. Red rectangles represent sell trades. Width of each red rectangle represents the amount of shares sold at corresponding discreet price level. Number of additional shares sold at each level is shown next to the rectangle. Also, larger font size is used for larger amounts to visually emphasize importance of pyramidal sells. Rectangles are framed into a pyramid for clearer distinction and easier shape discrimination.

Symmetry

Taking a distant view of deeper price oscillation, we can observe certain symmetry between actions that occur along the downward and upward price moves. Take a look at Figure 5 and observe that buy and sell pyramids are exactly the same, except inverted (or flipped). Conclusion is: Only one pyramid is enough to determine both buying and selling.

Fig. 5. Symmetry of buy and sell pyramids

Vertical symmetry is a consequence of equidistant buys and sells as the price moves down and up. All buys and sells are exactly one step apart. Horizontal symmetry is a consequence of no intended accumulation of shares upon executed deeper price oscillation. In other words, if we add up all the amounts of shares purchased it is exactly the same as the amount of all shares sold. In our example, we buy 10+20+30+40=100 shares. Then we sell 10+20+30+40=100 shares. After completion of price oscillation, we are left with zero shares (and whole bunch of profits).

The approach of symmetry works perfectly in a sideways market. However, during trending markets we intentionally introduce asymmetry. We will address ways to create asymmetry in future articles. Profit considerations comprise topic for itself and that will be addressed in future articles as well.

Hourglass

Now, let’s broaden our Pyramid Investing terminology with some new terms. But before, let’s rearrange our buy and sell rectangles so they are center symmetrical. In addition, let’s move the sell pyramid on top of buy pyramid (see Figure 6). Now we lost the price association part, however the shape obtained resembles hourglass. Therefore, when we want to point out the nature of changing amounts of buys and sells as we trade in and out of certain stock, we tend to refer to hourglass. We even derived the verb “hourglassing” that stands for process of acquiring and disposing shares in an hourglass way.

Fig. 6. Hourglassing or Pyramiding

Take a look at the address bar in your web browser – you will see a little hourglass icon that was certainly not chosen by accident. The same hourglass icon appears in your favorites or bookmarks to give you association with Pyramid Investing.

Another term that is equivalent to hourglassing is “pyramiding”. We tend to say: Pyramiding in and out of position. Pyramiding refers to buying and selling shares in a pyramidal way or following principles of Pyramid Investing.

Dear readers, Pyramid Investing concept is doing great! As a matter of fact, it kept exceeding my expectations since its very inception in June 2009. Particularly nice and generous profits were flowing in for the last four months as the precious metals market broke to the upside. Volatility hasn’t been extreme in any way, and yet the annualized returns achieved were way above the average. Risks taken were minimal. I would dare to reiterate that Pyramid Investing risk-to-reward ratio is smallest of any investing approach anyone has ever though of!

Trading along the pyramids has been robotical as it is supposed to be. Yet the excitement of such trading was outstanding. Pyramids respond to the King Price. They don’t care about anything else. They bring the peace of mind and worriless state for investor’s stomach. Stress remains the term unknown to pyramid investors. Some of the trades produced an ever increasing wondering about the other side of our trades: “What were they thinking about!?” That happens all the time when we buy at the exact low and sell at the exact high!

As I am posting this on the last trading day of 2009, I would like to express great satisfaction with Pyramid Investing concept and consistent profits I was able to realize throughout the year. Thanks to Pyramid Investing, this year will certainly be remembered in my investing career as a turning point. I haven’t booked a single loss and not only that, I am confident that not a single investing loss will ever be booked in my account as long as I invest! You should be able to achieve the same with your investing account.

Looking forward to 2010

I am looking forward to new 2010 with enormous excitement. But don’t get me wrong, times are not rosy at all and troubles mount with each coming day. The fight for financial security, not to mention survival, will be on top of the list for many a fellow citizens.

I have embraced Pyramid Investing with both of my hands and I am convinced I have one extremely powerful tool to come out as a winner from that fight. Not only that I am not afraid to step into the market fight, but I am looking forward to it and I am absolutely positive about the outcome. I don’t know where the market is going, neither do I want to predict or anticipate any direction. But I do know I will be on the winning side no matter what. You should be able to join the victory as well.

New Year prospects

New 2010 will most definitely bring us many pleasant moments. However, we should prepare our selves and be ready for unpleasant surprises as well. I expect a great deal of turmoil in financial markets in upcoming years. Volatility is only going to increase. Ordinary investors are not going to enjoy the roller-coaster ride. Not all the professionals are going to like it either. Actually, only few are going to fare well in such an environment. As a pyramid investor with proper setup of pyramids, there is nothing to be concerned with. Volatility is our friend and we will make the most out of it. Our ride is virtually guaranteed to be joyful with plenty of rewards along the way.

New Year is expectedly going to bring few drastic changes. Ordinary investors who are used to of seeking shelter and safety in cash and bonds are likely to face a dose of unpleasant reality. The risk of inflation is highly elevated and the prospect of cash losing its purchasing power is close to a sure thing. Consequently, the interest rates are likely to abandon their artificially low levels and start rising again. The impact would be felt by ordinary consumers, new home buyers, businesses and the overall economy. The bond multi-year bull market runs a great risk of turning into a major bear market. No safety will be found in bonds. The vehicle of choice is going to be market of stocks.

But one needs to be extremely cautious. Not all the stocks are created equal. Along with grim prospects for the overall economy, many businesses are likely to suffer, rendering their stock a bad choice. Pyramid Investing remains dedicated to precious metals market. The emphasis is surely going to be given to gold bullion and gold stocks. Energy and food commodities will remain our highly respected runner-up choices. As a means of insurance, general market indices such as Dow, FTSE/Xinhua and Hang Seng need to be utilized in a long sense. Of course, weighting of portfolio components and specific pyramid costs ought to be meticulously planned and maintained.

Having Pyramid Investing in your mind and applying it in your investment account is going to represent a crucial means of successful market operation and achievement of financial victory. This is likely to hold true not only for the upcoming New Year but for the whole upcoming decade and longer. Time and effort invested in mastering Pyramid Investing concept will pay off manifoldly. Being prepared almost equals applying Pyramid Investing. During tough economic times, capital preservation is of utmost importance. However, prudent capital management along with Pyramid Investing offers opportunity to grow investor’s capital base even in such circumstances.

I would like to wish you a happy new Pyramid Investing year! This blog will be around to offer you support in shaping your investing account and help you create some fabulous returns. This is going to be another winning year for all of us, because consistent profits are achievable, after all!

There are several different ways one can look at Pyramid Investing concept and associated philosophy of trading. Since the concept is so profitable, one keeps wondering all the time (including myself) – How’s that possible? Wouldn’t everybody be applying such a concept if it really worked that well?

One of the key principles that makes Pyramid Investing possible is strict adherence to price relativity law of buying only price weakness and selling only price strength. But let’s start from the beginning.

Uninformed, nonbelievers and successful investors

The fact that not everybody applies Pyramid Investing does not invalidate the concept at all. There are at least three different groups of investors from the Pyramid Investing perspective.

Probably the major group is a group of plainly uninformed investors (or misinformed for that matter). They have no clue about existence of a concept like Pyramid Investing. They don’t even realize what they are missing.  Besides watching their account balance in red most of the time they keep wondering what’s going wrong. I used to belong to this group when I started as a young investor.

The second group is much smaller: investors who belong to this group have been informed. The problem is, they still do not believe in what they have been informed about. Since you read this blog, you can consider yourself being informed – you ARE aware that there is something called Pyramid Investing out there. Just being informed makes you well ahead of the herd. Being informed in a right way is a big step in right direction. But that alone is hardly going to make you any profits.

The last group is vastly smaller than two other groups. Investors who belong to this microscopic group are very well aware of the Pyramid Investing principles. But not only that, they are seriously convinced that Pyramid Investing is not only a viable concept, but that it is capable of making some serious profits for them. They do believe in Pyramid Investing and they know it is not just another scheme, especially not one of the scam schemes.

Investors who believe in Pyramid Investing and do apply it on a daily basis, make consistent profits that confirm their beliefs even stronger. This is one virtuous cycle. Once you start investing per Pyramid Investing principles, you become a permanent member of that small group of successful investors.

How do I become a believer?

But how do you jump over the threshold and decide to begin applying Pyramid Investing? How do you initiate that virtuous cycle?

My intention is to educate you enough so you can start applying Pyramid Investing on your own. I am sure you will permanently stick to the concept after you book your first couple of profits. Then, you will keep coming back asking for more. You will return to this blog and read every single word over again trying to extract as much information in attempt to become even better pyramid investor!

But I have to gain a little bit of your trust first, before you will even consider starting.

As I mentioned at the beginning of this article, Pyramid Investing philosophy can be looked upon in a few different ways. These ways are very similar in nature and I want to present you with one of them now. I hope it will make you think about Pyramid Investing and hopefully you will come to decision to begin applying Pyramid Investing in your own account.

Buy low, sell high (has no practical value)

We all heard for a general investing principle: Buy low, sell high. This is easier said than done. By itself, this saying means nothing or in the best case it is incomplete. The fact that you are familiar with this saying isn’t going to make you any money. The problem is you never know for sure how low is low enough and how high is high enough. The problem is you are looking for absolute low and absolute high.

Absolute lows and highs are impossible to recognize when they occur. They can be realized only after the fact but then it is too late. Even then, they can be broken. Thus searching for absolute lows and highs is impossible and futile endeavor.

Price relativity

My favorite saying is: Everything is relative. That includes low and high prices. Pyramid Investing does exactly that – it appends the “buy low, sell high” saying with relativity. In other words, Pyramid Investing will want you to trade when price is relatively low or relatively high.

$1,000 Honda Accord?

On the other hand, if I tell you: “You can buy a car for $1,000”, you will say: “It is cheap”. Cheap compared to what? Compared to a nice, fully functional, clean car that you may have in your mind, it is true. But if I say: “It’s an old clunker with a broken transmission”, you will say: “It is expensive”. So price itself means nothing. You need to know more so you can compare and make a judgment. That is relativity I am talking about.

Yet, I can further argue that you don’t need to know anything about the car! I can simply tell you this: “You can buy a car for $1,000, but this is the last one – there were hundreds of identical cars like this last one and they were all sold for $5,000 each!” Would you even think about saying “It is cheap” or would your hand already be in your wallet? Thus everything is relative.

Price weakness and strength

Similar holds for stocks. They are also sometimes relatively cheap, sometimes relatively expensive. I am not saying you don’t need to know anything about the company whose stock you intend to buy, but looking at the price only, you can tell most of the time if it is relatively low or relatively high. Certainly, knowing some history helps: Look at some stock that trades at $20 now. If that same stock traded at $10 a month ago, it would make it relatively expensive now. Conversely, if that stock traded at $40 a month ago, it would be considered relatively cheap now. Thus, once the relativity has been introduced, the same price can become relatively low or relatively high just by looking from what price level the current price comes from.

Once you introduce relativity in price domain, you are not talking anymore about low or high prices. Then, you are only talking about relatively low or relatively high prices. There are even better expressions you can use: weakness and strength:

• Price weakness stands for relatively low price
• Price strength stands for relatively high price

Thus we finally modified the well known saying “buy low, sell high” per Pyramid Investing philosophy: “buy weakness, sell strength”. Pyramids help us determine existence of price weakness and price strength so we know exactly what trade needs to be done. And it always holds the following:

• Price weakness => we are on the buy side and we never sell
• Price strength => we are on the sell side and we never buy

Breaking adherence to these two simple rules in Pyramid Investing is considered a heresy. In Pyramid Investing, we always and exclusively buy relatively low priced items that express price weakness. Conversely, we always and exclusively sell relatively high priced items that express price strength.

The addition of relativity to price label makes Pyramid Investing realistically applicable concept that WILL make you some money. Of course, there’s more to it, but I hope this clarifies the concept a little bit better and makes you believe in its viability at least one notch more.

In Pyramid Investing, it is crucial to recognize the importance of price. Price is King! Everything revolves around price – our feelings, our actions, our profits. We may disregard many other aspects of investing and still manage to come out whole at the end. However, neglecting the price is a catastrophic error in financial sense. The price importance may seem obvious and it may appear impossible to lose track of price, but in reality, many market participants tend to become preoccupied with everything else but price.

In Pyramid Investing, price is constantly in our focus. We take care of many aspects of investing along the way. However, our actions are solely determined by price. We plan and prepare for every possible scenario but when certain price levels are reached, actions follow immediately with no hesitation whatsoever.

Volatility

Price constantly goes up and down whenever market is open. Sometimes it changes more, sometimes it changes less. This phenomenon of constant price moves is called volatility. Volatility is affected by many different factors: market news, investors’ feelings of greed and fear, liquidity, sectors, seasons, time of the day etc… Volatility exists whether we like it or not. Some investors are scared by volatility and they try to avoid it or reduce the exposure to volatility at almost any cost. That is mostly the consequence of number of myths and investing misconceptions. It is also true that some investing techniques are not designed to withstand excessive volatility.

Conversely, Pyramid Investing happens to be an investing concept that embraces volatility. We realize that if there would be no price changes, no profits could be made. The concept exploits price increases to book profits and price decreases to prepare for future profit booking. Every change in price is welcome. As a matter of fact, the more the price changes the better and the more frequently it changes the better. This sounds like not only that volatility is fully embraced but it is wished for!

Wondering about price

Even the most inexperienced lay investor understands very well that price changes all the time. However, the notion of ever moving price is not enough. Certain questions are normally asked:

• How does one make sense of price and price moves?
• How fast do prices change and what makes them change anyway?
• How do we react on price changes and do we always need to react?
• How do we anticipate future prices and how much and in what direction are they going to change from here and now?
• What is the relationship between price and profits and why it is so important to respect price in order to make profits?

These are examples of questions that naturally run through every investor’s mind. It may be impossible to answer some of these questions, but as you will realize later, we don’t need to answer all these questions in order to make money in the market! Some price related questions are actually irrelevant but that may make things worse since we need to identify those to not bother answering them. On the other hand, finding answers to some other questions may be critical.

Assumptions

In order to make sense of price moves, we need to define basic price oscillation. But prior to that, I would like to mention a few important assumptions:

• Price changes in time. For now it doesn’t matter what the rate of change is. In other words, we are not concerned by how fast the price changes.
• We neglect the short time periods when the price does not change. If we pick period long enough, the price changes for sure. “Long enough” may be one second, one minute or even one day but very likely less than just a few minutes.
• Price can start changing upwards or downwards from a certain price at a given time instant. For the sake of simplicity, we observe downward move as an initial move. As we will learn later, the quality of our analysis will not be diminished by this simplification.
• We use term price without any specific investing vehicle in mind. It may be price of stock, bond, silver, mutual fund, futures contract etc… The concept of price analysis is same and equally important regardless of investing vehicle in question. Actually, we will often refer to stocks but by no means will we be limited by stocks.

Basic price oscillation definition

In general, price charts show complex patterns and most of the times erratic price moves (see Figure 1 as an example of price chart, courtesy of Google finance).

Fig.1. Example of price chart and erratic price moves

Contrary to beliefs of many technical analysts, future price moves are impossible to predict with great (if any) certainty. But that is not the point at this moment. The idea is to define the basic price oscillation that can be used to build any price chart, no matter how complex it may be. To help us with basic price oscillation, we analyze a simple price chart given in Figure 2.

Fig.2. Basic Price Oscillation

We can observe a simple “U” or “V” shaped price oscillation. As assumed above, the price starts with a downward move. It reaches some lower price, turns around and continues with an upward move all the way to initial price. Since the price ends up where it started, we use the term oscillation. We are not concerned with the rate of change, thus time designations on time coordinate are intentionally omitted.

Looking at the price coordinate, we can observe three discrete price levels:

• Top is where the price starts and eventually comes back to. It corresponds to price p₀.
• Price runs through one step lower price level on the way down and again on the way up. This middle price level corresponds to price p₁.
• Finally the price level that corresponds to price p₂ is never reached. The price turns around before it drops to this price level. This level is again one step lower from the previous price level.

In accordance to previously defined Pyramid Investing terminology, we use Depth to designate how many discrete price levels the price drops relative to the Top. As a matter of fact, this basic price oscillation can be defined for any three price levels. Since our objective is to implement basic price oscillation to Pyramid Investing, it is convenient to use related terminology from the very beginning.

Therefore, our three price levels are shown by three horizontal green lines and designated with Depths 0, 1 and 2. The price curve is shown by thick black line. How many intersections can we observe between price curve and price levels? First, the price never reaches bottom price level, so no intersection there. There are four intersections above – two with top price level and two with middle price level. Each of those two price levels is crossed twice: first when the price goes down and again when the price goes up.

Actions and trades

Now, let’s see what happens at each intersection:

• First intersection is where we start observing the price movement (Depth is 0). That is likely the current price of underlying stock. At this intersection we only make note of the price so we can possibly act on it later. At this time, we should already have in place the pyramid we want to apply.
• Second intersection is where price crosses the middle price level on its way down (Depth is 1). Since the price comes from some higher level, this is considered to be price weakness. We buy predetermined amount of shares at this intersection.
• Third intersection is where price crosses the middle price level for the second time (Depth is 1), but this time on its way up. No action is performed at this intersection.
• Fourth intersection is where price recovers and crosses the initial level we took note of earlier (Depth is 0). Since this time the price comes from lower level, this is considered to be price strength. We sell predetermined amount of shares at this intersection.

In this basic price oscillation example we have two trades: one buy and one sell. The amount of sell is same as the amount of buy, i.e. we sold everything we bought. The colors of transaction rectangles are standardized to: blue for buy and red for sell.

Smooth curve and insignificant intersections

We can also make observation that black thick price curve is smooth. In reality, during very short time periods, price changes suddenly and abruptly. The curve is never perfectly smooth (take a look again at Figure 1). Even during longer time intervals, price never goes straight in one direction. It is common to experience many smaller ups and downs either when it trends upward or downward. For the purpose of Pyramid Investing, these small price digressions can be ignored and the curve is smoothed to make it more practical. It is intersections of price curve and discrete price levels that we are primarily interested in.

However, not even every intersection is significant. Take a look at the Figure 3. Here we have a price curve that crosses Depth 1 level four times! We see that when this level was crossed for the first time, the purchase was made. Trade at certain price level actually disqualifies that price level at least until next trade occurs at some other price level. Therefore, no matter how many times the price crosses disqualified level, no action is performed. We will analyze this dynamics in more detail later on.

Fig.3. Example of intersections of no significance

Finally, let’s reiterate the most important aspects of basic price oscillation: Basic price oscillation is change in price along simple “U” shaped curve. Price drops little more than one step before it fully recovers. One purchase and one sale may occur as a consequence of respective price weakness and strength. Basic oscillation can be scaled and inverted and then repeated as necessary in order to create price charts of arbitrary complexity.

In earlier article we defined price-related terms and talked about discrete price levels. Now we need to look at the horizontal coordinate and define amount-related terms. In the article Coordinate System in use for Pyramids we saw that horizontal width of a particular pyramid rectangle corresponds to the amount of shares. Due to the nature of pyramidal shape, the pyramid gets wider towards the bottom. This is actually one of the key Pyramid Investing principles – the amount of shares purchased increases as the price of underlying stock goes down.

But before we can quantify the amount of shares that relates to particular discrete price level, we need to define a few terms. Let’s look at the following figure:

Definition of Amount-related terms: Size, Base & Increment

Look at the horizontal dimension of pyramid – the amount coordinate, and observe three new amount-related terms:

• Size
• Base
• Increment

Unit for amount related terms is share

All three amount-related terms use the same unit. However, we mentioned earlier that amount may represent either amount of dollars or amount of shares. Therefore, depending which one we use for a particular pyramid, the unit of amount gets to be either dollar or share, respectively.

We predominantly deal with the amount of shares and thus we assume that the unit for amount-related terms is share. Only on rare occasions when we explicitly mention so, we consider dollar as a unit for amount-related terms. One of those occasions is application of Pyramid Investing to 401(k) mutual funds. There, we use dollars in order to avoid dealing with units of different mutual funds.

I think it is worth mentioning that the logic and use of amount-related terms always remain the same regardless of unit we choose to apply for particular pyramid amounts.

Another obvious fact is that wider pyramids deal with larger amounts and vice versa. Looking at any single pyramid, we observe that pyramid gets wider towards the bottom, and consequently the amounts we deal with also get larger towards the bottom. With the increase of depth, we normally consider only linear increase of amounts, although alternative (and more complex) approaches may deal with exponential or some other relationships.

Definition of Size

Size is general term that we use in relationship with horizontal dimension of pyramid. Therefore, we have the following definition: Size is a measure of pyramid width at the specific price level.

For typical pyramids, size varies depending on price level within pyramid range. The smallest size is found at the top of the range and it becomes larger towards the bottom of the range. As you can see, term size is equivalent to the amount.

Definition of Base

Base is one specific pyramid size – the size at the top of the pyramid. Base is shown on the figure above. We can define this term using following definition: Base is the size of pyramid’s top.

As you can observe from the figure, our pyramid has a “flat” top. Base is the width of the pyramid at its top. Base is also the smallest width of a pyramid. Since we know that base relates to the amount of shares, it expresses the smallest amount of shares to deal with when applying certain pyramid.

As we are already aware, the whole idea of introducing pyramid shape is to help us determine discrete price levels and associated amounts we trade. But we need to be careful since it is not practical to trade extremely small amounts of shares. In addition to not being allowed to trade fractional shares, it is not practical to trade one or two shares of cheap or penny stocks. This makes even more sense when we account for trade commissions that are unavoidable factor in trading stocks.

Now you realize why we needed to “clip” the top of triangle when we performed our geometry play in order to obtain basic pyramid shape. We wanted to achieve some non-zero size at the top of our pyramid due to practical considerations. Base is the smallest amount of shares we trade along the pyramid we specify.

In the process of shaping pyramids, we have a freedom of choosing appropriate base depending on other factors such as top of the pyramid, commissions and amount of trading profits we want to achieve. As we will discover later, shaping pyramids is somewhat an artistic act that determines risks we take and eventually profits we obtain. In other words, shape of a pyramid directly determines how aggressive or conservative our approach to the market gets to be.

One important distinction I want to emphasize regarding the term base is that it is used to measure the size of pyramid’s top, not bottom! You may want to naturally associate base with the bottom of pyramid, however, you need to remember that we always start from the top of the pyramid. Therefore, base is the amount we start with in building our position in a pyramidal way.

Definition of Increment

So we start from the top of the pyramid. We buy the base amount of shares at the price that corresponds to the pyramid’s top. When the price drops to the first lower discrete price level, we buy additional amount of shares at that level. We want this additional amount to be larger than base amount. How much larger the additional amount gets to be compared to the last amount bought is determined by increment. Thus we have the following definition: Increment represents the difference between amounts at two adjacent discrete price levels.

It holds that adjacent discrete price levels have consecutive depth numbers. Thus as the depth increases, each additional amount is larger for the amount of increment. In other words, to come up with new amount, we need to add increment to the old amount. Once the trade is executed, new amount becomes old and we repeat incrementation with the next trade.

Increment doesn’t necessarily have to be a whole number. If it is a fractional number, the amount of shares may happen to be fractional as well. Since we are not allowed to buy or sell fractional shares, we perform rounding of shares we deal with.

This article rounds up defining terms that relate to pyramid’s vertical and horizontal dimensions. There are still few terms remained that relate to cumulative pyramid measures – surface areas as well as pyramid names based on price range coverage. Those are going to be addressed in future articles.