Pyramiding is a speculative technique that people use to increase profits by building on prior unrealized profits. When the market is strong, this technique can be successful as long as it is artfully performed 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 large financial liability. This technique tends to be used more commonly among highly experienced speculators, rather than new investors and conservative investors.
In pyramiding, the margin created with successful trades is leveraged to buy more shares or other investments. As the investor increases the size of investments, the margin grows, and it can continue to be reinvested and used. If the investor times the process carefully, trades can be completed to turn the paper margin into real money. If the pyramiding is not performed carefully and the value of shares being used to sustain the margin starts to fall, the investor can run into trouble.
Brokerage houses allow people to trade on a 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 surrender securities to the broker so the broker can sell them and close the gap. If someone is relying primarily on unrealized return in a pyramiding investment plan, the margin call may be too big for the investor to pay.
The concept of pyramiding also comes up when corporations and other businesses heavily leverage themselves in order to expand and engage in other activities. Their debt is carefully spread and they regularly move it, repaying one debt with another debt in order to expand the capital they can access. As with stock pyramiding, there are high potential risks if the scheme starts to fall apart. The company may be so heavily leveraged that it will have to declare bankruptcy.
This term also comes up in the form of illegal schemes that rely on using people to attract investors to a plan that is largely based on profits that do not exist. In a pyramid scheme, people are told that they can buy in on an investment plan with big potential returns, as long as they agree to recruit friends. As recruits join, their funds make their way to the top of the pyramid and they never actually see returns.
