Addicted to Average Down?

This is one of those damned if you damned if you don’t issues

Can it blow up your account – yes
Can you use it to work out of a losing position – yes
Can you use it to build into a position – yes
Do some use it as a crutch to cover up (hopefully recover from) bad trading technique/ decisions – yes, unfortunately
Can you make a bunch of money using it – yes, and unfortunately this aspect is what too many less experienced traders get caught up in


I’ve thought long today whether I should post this part – but what the heck – it is what it is


I reference this thread so you can see 64.48 - $64.88 is a S&R area I’ve been using for awhile.

http://www.elitetrader.com/vb/showthread.php?s=&threadid=185807&perpage=6&pagenumber=2



RIMM Friday

1.) Opened – $63.39

2.) I set up an opening range = OR

3.) Price only barley dipped it’s toe below the OR during the first 15 minuets after the open – so I went long

4.) Price rose quickly above the OR, to $64.21 – then reversed hard, I exited ~$64.10

5.) As price proceeded down/ thru and below the OR – I shorted when it retested the lower OR

6.) Price then moved down a bit, stalled, then dashed back up above the OR – I was in a loser and feelin some heat - time to make a dispassionate decision – exit, obviously for a loss…. or not

7.) So (going back in my memory bank) let’s see… Thursday was a down day, Friday the mkt was down, no real buyers, a couple of other things indicated down, and add to that the $64.48 - $64.88 S/R level

8.) I made the decision to hang in there and average down – figuring at minimum I would get a retrace/ bounce from $64.48 which would at least allow me to get out at break even/ smaller loss, or even get a better price for a gain if this current move was a head fake – if I averaged in with forethought and deliberation.

9.) After some quick math I averaged in a couple of more positions at different price levels above my initial entry – suffice to say by doing this my cost basis was well above the OR I had identified, and at the top level of some intraday short term S&R established since that morning’s open.

10.) Long story short price rose to $64.31 (short of the $64.48) and proceeded to sell off hard throughout the remainder of the day

11.) My hard stop loss would have been a price close above $64.48 (btw I was expecting a head fake above $64.48 but even that never materialized)

This time it worked, next time it might not – but I completely accept that, and the associated loss I will incur when it doesn’t… And I will never average in just for the hell of it, or to put off/ delay taking a loss


What’s my point to this – be flexible, know the battle field, have a plan with contingencies, be willing to modify your plan if/ when necessary, keep your emotions out of the equation, trade within yourself, execute your plan, accept the results

Blindly saying averaging in will/ won’t work – is not good trading, nor the truth…. saying it is a tool to be used prudently – is good trading, and truthful – IMHO of course

But it bares saying again – averaging in will absolutely blow up an account if not used prudently and judiciously


RN

 

That is fantastic.

Unfortunately people seem to forget it on a regular basis.

 

Hi RN,

I agree that averaging down is definitely a tool used for trading, but I think it doesn't has to be used. Our risk/reward per trade is what determine the expectancy of our strategies. Average down does not enhance the expectancy in any way. In the long-run, averaging down will ruin the strategy.

Also, I think we have to be careful in our view of what is prudent or not. To me, as a newbie, I never know what price will do after I place my trade. Averaging down would not be prudent. The only prudent thing I can do is to use my stop. Even if I have years and years of experience, I am sure that I still won't know what price will do after I place my trade. The only thing I will know from experience is that anything can happen. So, the only prudent thing I will do is use my stop.

I believe there is no prudent way to use average down, because we don't know what unpredictable things are going to happen next. Even if something that look safe to average down on, like Coca Cola, it may not be the case when the price is falling (for whatever reason). In the market as in the world, nothing is as it appear to be.


PA

 

Hey PA,

No argument here Sir


RN

 

Nope... Increases the risk... I average down until my risk for the stock is fulfilled or the stock is profitable.

Again going through the numbers averaging up has the problem of increasing your risk without added gain.

 

I thought so I would get this reaction. And frankly I don't care. Why? Because I do things by statistics and probabilities.

I am an engineer by trade and frankly I hate risk. So when I got into the stock market game I decided to use my programming skills and thought, what would be the best strategy?

About 5 years I read the books, and programmed systems. And since my specialty is AI I let the systems find its own steady state. I wrote a day trading system and let it find the best way to day trade the QQQQ's or SPY. When the system optimized itself what it found out was that:

1) The most profitable day trade systems are ones that make around 2 trades. Going in and then getting out.
2) You can overtrade.
3) You can hit the broadside of a barn, meaning just because you were wrong does not mean doing the opposite will be right.

In this day trading system I used stop losses, and what boggled me was that the system would only apply a stop loss for those trades that could be classified as dead cat bounces. Statistically speaking 5% of the loosing trades were stopped out, no more. Every time I used a closer stop my net returns kept dropping.

Upon closer investigation I found out that with stoplosses there is a very high probability that the trade will bounce back. So you get stopped out, maybe switch direction, markets bounces back giving you a slight gain, before dropping in your the original direction causing another loss. I saw this statistically and it boggled the hell out of me...

At the time I was a beginner trader, and thought why is this? And all of the answers I got was that my system had a bug, or it was not true. Because I was conflicted I just decided to drop and not look at it again.

That is until about 2 years ago. I met up with a very profitable trader who was part of a fund and they needed somebody with business experience to help them move to the next level in terms of automation and backtesting.

This very profitable trader (20 years of experience) went through the same experience as I did. He bought options, and did momentum trades. But his conclusion was like mine. If you are willing to take the other side you will be more profitable.

The illusion that you will get walloped is due to people averaging down when they should not be. If people are averaging down now then they don't have their head screwed on right. If people were averaging down in Feb or March 2008 then the record shows we were right!

If I had to pinpoint it... You can't average down with momentum or swing trading. But you can average down with contrarian.

So to say averaging down should be stopped is missing a perspective of the contrarian.

 

The "prudent' thing to do here is to conclude you simply do not trade....

It isn't what you say, it is how you say it....


NiN

 

I remember watching this video of how LTCM blew up. It is still very shocking to me, because these guys are highly intelligent with many years of experience in the market and in research. A couple of them are even Nobel Prize winners. In terms of their ability to predict where price will go or how the market move, they would be fairly good at it. However, they fell victim to average down and blew up big (the government had to bail them out).

These guys at LTCM had made huge returns and knew what they were doing, yet they still blew up. What I learned from this is that average down doesn't work even if we know what we are doing.

PA

 

By definition, by blowing up they proved they didn't know what they were doing.

 

I agree but I just wanted to point out that a false sense of certainty combined with averaging down caused them to blow up.

PA