Coordinate System in use for Pyramids

Coordinate system

In the previous post, we performed a little geometry play to come up with the basic Pyramid Investing shape. That shape is somewhat pyramidal and helps us determine how much and at what price to “buy” or “sell”. Before we can really use some help from that shape, we need to make sense of its two dimensions. Thus, we will put the shape in a 2-dimensional coordinate system. The coordinates are:

• Vertical coordinate – PRICE – What price?
• Horizontal coordinate – AMOUNT – How much?

Pyramid shown in its coordinate system

A little bit of mathematical jargon

I would like to mention that we use inverse logic compared to what we might be accustomed in mathematics. Normally, we would use horizontal axis (x axis or abscissa) to show independent variable and vertical axis (y axis or the ordinate) to show the dependent variable. In Pyramid Investing, we use vertical coordinate to show price, which is our independent variable – we have no control of price whatsoever. We use horizontal coordinate to give us the dependent variable which in our case is amount. Amount depends on price.

Amount is number of shares or dollars

So far I posed the general question – How much? Actually, we deal with individual stocks, ETFs or even futures contracts. We may also deal with mutual funds or Forex trades. In any case, the right question to ask is – How many? It basically boils down to either:

• How many shares or
• How many dollars

Most of the times when we want to express the amount, we will refer to number of shares. In a narrow price range, there is little difference between using shares or dollars. However, we will normally cover wide price ranges, thus it is important to make the distinction between the two. The following example illustrates the distinction:

Let’s say we want to buy 100 shares at two different prices: $10 per share and $8 per share. One purchase costs $1,000 and the other $800. Thus even though we buy the same amount of shares, the amount of dollars we spend is different. We spend fewer dollars when the price goes down.

Conversely, let’s say we want to spend $1,000 for buying shares at two different prices: $10 per share and $8 per share. In one case we get 100 shares and in the other we get 125 shares. Now, even though we spend the same amount of dollars, the amount of shares we get is different. We get more shares when the price goes down.

Price is King!

As we have seen, the amount depends on price. Later, when we get to analyze Pyramid Investing dynamics, we will see that price to amount relationship is not necessarily unique. The amount can also depend on the trajectory of price moves before certain price was reached or in other words, the amount can also depend on the price history. In any case, the amount of “buys” or “sells” is closely related to price and it is obtained based on the price. That is because in Pyramid Investing and in the world of consistent profits – Price is King!

I will probably repeat many, many times that Price is King. I simply cannot stress strong enough the importance of price in the process of making profits, even though it is an obvious fact. Many investors get astray and their attention gets overtaken by news, expectations or something else. They tend to focus on many different things and miss to react on price. Such behavior is not uncommon and yet it has disastrous consequences to investor’s financial success.

Time is irrelevant

One thing all investors are very familiar with is stock charts. Stock charts graphically represent stock prices within certain period in time. The coordinate system for charts is price versus time. We will also get to use charts quite often.

However, in Pyramid Investing, time is irrelevant. We never make any “buy” or “sell” decision based on time. The amount of time that passes since our last activity has no impact whatsoever on our next activity. Period.