Columnists
All about pyramids and how they can earn you clean cash
Friday February 16 2024
Pyramiding helps invetors take advantage of high performing assets. PHOTO | FOTOSEARCH
Nasir “Nas” Jones wears a lot of hats. He is a musician. He’s an actor. He’s also the owner of Mass Media Company. Yet, while his poetic prowess is legendary, Nas’s business acumen is equally impressive.
He is the founder of QueensBridge Venture Partners – a venture vehicle that has invested in more than 150 companies such as Coinbase, Robinhood and Dropbox.
While he’s never the type to muse on his business acumen and wealth in his verses, fans got lucky only recently. His 2021 album, Magic, had quite some gems. I’ll use a line from his song, Speechless; “Educate yourself, find 10 different areas of interest, Spread your bets out. Double down on what’s working, then you double up.” In short, that sounded like Learn. Diversify. Pyramid— adding to winning positions as price moves in the desired trend. The first two are obvious but the latter, not quite.
If you buy a stock, it rises, and you move the (mental) stop above breakeven, then you may buy more of the same stock, as long as the risk on the new position is no more than a predetermined risk level of your total account equity.
But since shares are limited by funds in the account, pyramiding is best executed in a futures set up because of its margin system. So, if one puts on small initial positions, fenced in by strict money management rules, they can pyramid them to the hilt as a trade moves in their favour and keeps moving stops beyond breakeven and adding new contracts.
Read: How to have a financially prosperous 2024
Now, for this type of strategy, one needs to pay attention to trends of the “open interest”, that is, the number of contracts outstanding on any given day, reported a day later – NSE reports this metric daily.
You see, in the futures markets, a new contract is created whenever a new buyer and a new seller come together. If both get out of their positions, a contract disappears. This metric goes up and down each day, and its changes provide important clues to the commitments of bulls and bears. Rising open interest shows more winners are coming into that market.
Just as important, it shows more losers are coming in because without their money there would be nothing for winners to take home. An uptrend in open interest reflects a rising level of commitment on all sides and indicates that a trend is likely to continue.
A downtrend in the open interest shows that winners are taking away their bets, while losers are accepting losses and quitting the game altogether.
Falling open interest shows that the trend is becoming weaker, which is a valuable piece of information when you need to decide whether to stay or exit your pyramid trades.
Read: How can I hedge my retirement investments against inflation?
You can say pyramiding is the opposite of “averaging down.” It’s taking full advantage of high-performing assets and maximising returns. It works (only in trending markets) because one is adding to winning positions and results in greater profits without increasing original risk.
Mwanyasi is MD, Canaan Capital.
