If you have a stock that you believe in, averaging down can be part of a useful strategy. To wit: I initiated a position on an int'l stock in summer 2008 with the goal of accumulating it for a few years because I didn't see it really 'taking off' and generating huge returns until then. So I got in at 18, added at various points down to 11 and then up to 30. It's now over 40 and thanks to my low cost basis, the position has returned over 100% gains that are now protected via put options. I have buy points on the way down again, too. That's fine by me, for I have done my homework and beiieve in the LONG-TERM prospects of this company. So in this case, I averaged both up and down, but it's not done on a whim but on a sound long-term investment plan. Of course, if you buy something like SDS at 70 and think of doubling down at 40 becaue it's tanked and you didn't manage your trade/risk well, well then I agree "averaging down" is a bad idea. I mean, hell, you can average down until your cost basis is 0. lol
Christian, thank you for your responses. I appreciate the help in trying to sort this out. (Thanks PA and RN too). Simplistic as I am, I think of risk being increased whenever position size is increased, regardless of the current profit/loss on my trade. But I am not just simplistic, I am emotional and at times act illogically. You however seem to be a methodical man. Any chance you could expand upon your statement that with your style of trading, averaging up increases your risk (more than does averaging down)? If itâs not too much to ask, perhaps something more detailed than âthe numbers showâ. And just in case you suspect that I am quietly mocking you, let me be clear. I am mocking ME.
Christian, I've enjoyed your sharing in this discussion as we trade very similar strategies. Have a question to ask, you say you start with 200 USD and add a max of 10 times. Is every add a lineal value ? ie 200.00 x 10 = max of 2000 or do you increase size as you add? Could you also please talk a bit about what your max risk is per trade once all 10 adds are in ? I notice you said you were managing 140 tickers, I suppose this means you implement diversification very strongly since you don't use leverage. Thank you for your time. No Heat
RN, thank you so much for this insight into your trading. I've sometimes done similar tactics, but always with a max loss chosen in advance.
My problem with this strategy is that if we are right from the start and we never add we have a winning trade on very small size. Yet the losses be on full size. No Heat
That's exactly why I no longer use the strategy, because psychologically I just can't bring myself to add to winners! Is that crazy? Past few months I would sometimes put on small size thinking to average if price moved against me, then price moved nicely my way and I'd be pissed I didn't start with full size. It never occurred to me to ADD TO THE WINNER TO GET TO FULL SIZE! Thing is, if I wait for a confirmed setup instead of trading based on my bias, I can go in full size with a limited loss zone. We all have to individually find a way of trading that fits our personality.
Here is the situation. Let's say that you have a stock. You can't predict whether you go up or down. However, most technical analysis and people do try to predict. So now you are caught in a bind because any money you put into the market is a crap shot. So assuming that there are crap shots, the question becomes how do you build high probability trades that will make you money? One way is momentum, where you apply the bigger fool theory. In other words you step into a stock that has momentum in a certain direction and you get out a bit later, but before the masses do. If you like momentum you listen to people like Garth. Another way is contrarian. Contrarian is when you buy on the cheap. You buy what everybody hates, or has blood. With contrarian your only risk is your pyschology. It is hard to jump into a trade in a true counter trend. Contrarians are people like Warren Buffet, like when he doubled down on GE. People were literally calling the old man a fool. Yet he did because he was running counter trend, and is quite richer because of it. So now let's say you are going to run a momentum trading system. You are going along a trend, and will exit the trade when the trend stops. Thus your way to make money is to keep adding money as the trade becomes more profitable, and instantly exit when the trend is done. People will add more money in this approach, but they will refuse to exit the trade because they believe they can squeeze that much more money out of the trade. Here is where I believe most people say, "oh I will just average down" even though that is NOT, and I mean NOT the thing to do. You are supposed to exit! In a contrarian system you have picked a stock that you believe is a great investment. However, the market for whatever reason believes it is not. Hence the price goes down. It is at this point you say, "no I want to buy." Momentum, like contrarian rely on the bigger fool. Whereas contrarian relies on the bigger fool to bring market down further. So as the price keeps dropping a contarian system will say buy more stocks. And this is where things become hard because the further the stock falls the more you have to analyze your risk position. Is your position too big? Are you willing to further hold or add? If as a contarian you decide to exit it is due to fundamentals, and not some arbitrary stoploss. So why not add onto your position as the stock becomes profitable in a contrarian system? When the stock becomes profitable you are in fact relying on momentum to carry you to exit position. And because momentum might be short lived you might have to average down further, until it eventually causes your position to exit. The trick with momentum is to exit the position and not let greed take control. And the trick with contrarian is to control the position and not let fear take control. Blow up's happen for a multitude of reasons. But among retail and smaller investors I believe it is because they can't get their strategy right. Momentum is not contrarian and contrarian is not momentum. You can't mix the two strategies and you can't truly be somebody who plays both strategies since their pyschology's are completely different. Thus you need to identify momentum play and contrarian play. The stock market from November onwards was momentum. The market from November 2008 to March 2009 was contrarian. Amazon at 100 and above is momentum, whereas Amazon at 30 is contrarian. A classical contrarian play last year for me were the automakers. I bought GM, Ford, Mercedes, BMW, Fiat, and Renault. All of them were bleeding money and it seemed that they all would go bankrupt. One did GM, and I lost 75% of my investment. However, I more than made up that with Ford 500%, Mercedes 35%, BMW 89%, Fiat 87%, and Renault 20%. So how come I made less money with Mercedes and Renault? I reached my risk limit and said, "either they make or they don't" Are there any contrarian car plays now? Sure, one company Volkswagen... Nobody wants to touch this stock because the company is "problematic". I agree Volkswagen has problems, but Volkswagen also has some incredible potential once they get their head screwed on right. Regarding a previous comment and LTCM. The real reason why LTCM blew up was not averaging down. Yes they did average down. But LTCM controlled too much of the market and had many players work against them. Had LTCM stayed a certain size they would probably still be in business today. Does this help? Or still wondering?
I know exactly how you feel, and it makes me wonder if you are contrarian. The way that I solved this problem is that I keep looking and scanning for stocks. About 4 months ago I was holding around 100+ stocks in my portfolio. What people forget is that with momentum or contrarian you ALWAYS have to be on the hunt... And right now the pickings are slim for contrarians. Great for momentum though... Though I can't bring myself to buy any momentum plays...
No Doji, I hear you loud and clear, I can't add to winners either. Especially when I come from the school of buy low and sell high. I do however add to losers with predefined max risk and most of the time this equates to instrument collapsing (ie Bear Sterns), I like to think my stops are in the diversification I do. Some will collapse yes but not all and by doing this I can close my eyes at night. Unlike Christian Im not engineer or pioneer, everything was taught by good friends. No Heat
NO, Good point What Iâve been seeing as of late (last few months) â the biggest price moves have been in the morning, with smaller range bound moves in the afternoon â that may or may not be a continuation of the morning trend⦠Except for this past Thursday of course My initial plan with contingencies took this into account I originally thought my first long was the beginning of the morning move â but then it failed pretty quickly â and I didnât wait around to exit that one â I got out Aside Funny that no one has noticed that one and asked why I didnât hold on and / or possibly contemplate averaging my long⦠so Iâll tell ya⦠I had size on / Thursday was a strong down day/ the market was in the red â I got the hell out of dodge with a hot key exit Okay on to the short Time wise the second trade (first short) was still relatively early in the morning, and having just been in a roller coaster ride I entered with smaller shares knowing if it had worked straight away â I would dog pile in with size quickly â it didnât so I had to make up a plan B on the fly (taking what I had been seeing, with what happen Thursday, with what I was currently seeing) Appreciate the battlefield in which youâre operating, have a plan with contingencies, and be willing to modify/ adapt those plans as necessary, and on the fly if required btw potentially the battlefield is changing but only time will confirm that Lot of thinking for a dumbass redneck no doubt - but I never allow my thinking to get in the way of my action RN