Possibly, but then so could chocolate be addictive. Averaging down is alluring, and the reflection of a gambler. Comforts a bruised ego. Averaging down, aka a Martingale, is compounding a mistake. If you burn your thumb on a range, or you going to put your index finger on there too? is playing to break even lucrative? Like women, move ON to another issue. There's a river of fish.
Yes. I retired at 40 in early 2001 from the Penny market. I was hurting and new in 1998 ... Bought a stock in at .43 and averaged down to .013 ... held a pile of stocks and it ran to over $1.00 I found a hat I liked. It was $30 ... then I found the same ones at a factory outlet for $12 ... I bought 9 more ... I averaged down. It is addicting. And it works sometimes ... like the hats.
PA, after months of testing averaging vs exiting and re-entering at a better price in my demo account, here is the result: Averaging "feels" better because you don't have to realize a loss, therefore as long as it works, you are always right. You can average into a loser until you have a $5K drawdown, then if all works out "as usual" you get out of the trade eventually for a $120 gain sighing with relief. But it was a winner! So you were RIGHT! Exiting for a small loss when the trade runs against you, then looking to re-enter at a better price requires focus, patience and solid skills at reading price action. You may get in on what appears to be a good setup, then price reverses and stops you out for a (gasp!) loss. You have a choice then to reverse your position or if you feel that the bigger move will eventually be in the direction you initially chose, you can wait patiently for a better price and good price action setup. This is the method that produced much larger net gains in my sim account when I was patient and stayed focused. I say net gains, because although the averaging strategy worked 90% of the time, the 10% of the time it failed badly wiped out a large chunk of the previous gains.
Actually I asked myself the SAME question. It turns out the approach would work IF you could predict the future movement of a stock. But since you can't you will always miss and get in at a worse position. Hence you just need to stick it out. I did this analysis using statistics as well and I found that stop-losses actually increase your losses because there is always a certain degree of bounce back. How many times have you said, "oh if only I held on a little longer." This is statistical correct. Going further into detail. I did quite a bit of studying of the markets since around the 1800's. And I looked at each of the failures and why people were knocked out. In each case of blowup it is because people ran out of money. I know this sounds sort of DUH... But it really boils down to that. Do I go on margin? Never! Never! Never! Right now I am sitting on 82% cash. And if Monday goes down then I will be sitting at around 92% cash. At the bottom in March 2008 I was sitting on 35% cash. When the market was collapsing I was buying, buying, buying... I ALWAYS keep enough cash around so that when things get tight I can deploy money. Do I ever loose money? Yeah I did once in 2008, I was down 18%, whereas the market was down 33%. The only reason I managed 18% was because there was this little bounce in 2008 where I cashed out quite a few positions offsetting the pounding I took for the remainder of the year. BTW I don't short stocks as a rule.
BINGO! If you have the account size you can ALWAYS make money. The problem I feel why people blow up is because they want to make oodles and oodles of cash. I try to make between 20% and 45% per annum. That's my goal, no more and no less. For example this month I made my monthly target, have lots of cash and lots of margin available. YET I am not going to deploy anything because right now the market is make me nervous... I will sit on my hands and watch...
I am going to disagree with you. Let's say that you are doing a pairs trade. So you enter a trade and you find that the gap widens against your position. You have at this time an unrealized loss. The question becomes do you exit? Answer no because as the gap widens the pairs trade is saying this is an even better buy. Just like Warren Buffet has said in the past if Mr Market drops the price of a company he likes he will just buy more. The reason why Buffet makes money is because he is careful with his money. Before the crisis he was quoted as being out of touch since he had over 40 billion of cash burn a hole. And then during the crisis he made a bunch of deals that many people thought were loony. Now who is laughing last? Cash is king, and will always remain king! People who do everything on leverage are asking for a bruising...
The last sentence says everything about the wrong approach you are taking. Why on earth did you have positions on hand that could wipe out your account? I learned that lesson very quickly, and vowed never to have a position get out of control. When I closed my GM position I lost 75% of my position. Yet I also bought F and made 5x my money in return. However, I made sure that when my GM position hit a certain size I stopped buying. I said either GM makes it or doesn't. Obviously it was the latter. Don't laugh, but I have a 6 digit account trading account, and when I enter stocks I buy 200 USD at a time. That is my rule. 200 USD sounds crazy, but I will average down max 10 times before I stop. Thankfully for IB it only costs me a dollar. Now do the math, if you had the ability to average down 10 times you can make money. Of course I don't always average down 10 times. Often only 3 to 4. It does mean that I have manage a large portfolio, and at the peak I was managing 140 tickers. There just was so much to buy. Not like now, I am down to around 20 tickers... Everything is overpriced...
I was comparing the two strategies in my sim account, not my live account. If I actually traded an account the size of my sim account I imagine I could use my leverage as an "edge", compensate for an inability to choose entries wisely by averaging down for quite a long while. But because I wanted to compare the two strategies using an account my size (mid 5-figure account), I had to have an "uncle point". Turns out the very few trades that reached the uncle point wiped out a large portion of the gains on the winning trades. I never built a position that could've wipe out the entire account.
Ok, I can understand where you are coming from. The problem with the averaging down strategy is that you need to pick the time carefully. And you need to pick the amounts to average down carefully. I figured these things out statistically by doing backtests. Doing this with trail and error can have disastrous results... The fact that the winning trades were wiped out by the loosing does surprise me. I have had moments where I cringe, but my winners have always made enough to overcome the loosers. Though I would advise that you use this approach with contrarian, and not momentum or swing.
Hi christianhgross, The biggest risk in the average down strategy is that it will get addictive. When things are working fine, it give us the positive reinforcement to utilize this strategy again and again. The good thing about your strategy is that it doesn't use margin and it utilize diversification to minimize risk. So the chance of losing everything is slim, but is still possible, since the world is a random place. My question to you will be, would you ever get desperate enough to mortgage the house or borrow money from family and friends to average down--especially considered how your consistent your return was using the average down strategy? PA