Pyramiding is a speculative technique used to increase profits by reinvesting unrealized profits, but it can backfire in a weak market. It is commonly used by experienced speculators and involves trading on margin, which can result in a margin call if investments fall in value. The concept also applies to heavily leveraged corporations and illegal pyramid schemes.
Pyramiding is a speculative technique that people use to increase profits by building on previous unrealized profits. When the market is strong, this technique can be successful as long as it is done by someone with experience in the financial industry. In a weak market, the technique can backfire and someone may be left with a collapsed scheme and a huge financial liability. This technique tends to be used more commonly among highly experienced speculators, rather than new investors and conservative investors.
In pyramidal, the margin created with the successful operations is used to buy more shares or other investments. As the investor increases the size of the investments, the margin grows and can continue to be reinvested and used. If the investor times the process carefully, trades can be completed to convert paper margin into real money. If pyramiding is not done carefully and the value of the shares used to maintain the margin begins to fall, the investor may be in trouble.
Brokerage firms allow people to trade on margin with the understanding that if investments fall in value, a margin call will be issued. When the broker calls, the investor must either provide funds to replenish the account or agree to deliver the securities to the broker so the broker can sell them and close the gap. If someone relies primarily on unrealized performance in a pyramid investment plan, the margin call may be too large for the investor to pay.
The concept of pyramiding also arises when corporations and other businesses are heavily leveraged to expand and engage in other activities. Their debt is carefully apportioned and they move it around regularly, paying off one debt with another to expand the capital they can access. As with stock pyramiding, there are high potential risks if the scheme begins to unravel. The company may be so heavily leveraged that it will have to declare bankruptcy.
This term also comes in the form of illegal schemes that rely on the use of people to attract investors to a scheme that is largely based on non-existent profits. In a pyramid scheme, people are told they can buy an investment plan with large potential returns, as long as they agree to recruit friends. As recruits join, their funds rise to the top of the pyramid and never really see any returns.
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