Pyramid Investing

True Market Players and Wealth Transfer

Truth is elusive

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.

Pyramid Investing Portfolio – Action in Gold Market

Realistic portfolio behavior

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.