I average in both shorts and longs as needed. Seems like the key is to start with a postion small enough so averaging can work. For and account under 50K this is 200/300 share lots and you have to give the stock plenty of room to move 4 or 5 points. Does not work as well for daytrading where averaging will give you a 3000 share postion going the wrong way. Ouch.
I think this is what separates the men from the boys. The mindset going into the position must be made with extreme confidence, otherwise you will get taken out. To take it even further, IMHO, a losing trade should not be in the equation, yet. Bouncing price action can be an opportunity to add at the lower range. So to me, it's just a continuation of the existing trade. Side bar: My heaviest losses and gains have been attributed to this...uhmm...technique.
If you're going to average down, that was your strategy to begin with. So...you started off with very small size, much much smaller than you would on your normal trade. And you have a target in mind. And that target is not breaking even. Woe to him who puts on an upside down pyramid and has it all come crashing down on his head.
For the record, when I mentioned the research I've recently begun on adding to a position on a pullback, I should also have mentioned that these adds are _not_ beyond the stop specified by the strategy. That stop remains in place from the inception of the trade, and is never amended to be farther away. On occasion, the whole position, including the "add-to" portion, gets a subsequent progress evaluation, and if it isn't productive, an earlier, tighter stop is invoked. I say this because I completely concur with the danger of blowing stops. Incidentally, I also agree with the poster above who said the option of adding should be specified in the strategy before even the initial position is entered.
I have certainly done that in the past, adding on to losing positions, as a percentage I would say it has worked for me probably 70% of time. But on balance it has cost me money. One can certainly rationalize the concept of adding to losing position, its a very comforting thought turning losers into breakeven; but imho its like running a red light, nothing may happen a few times, but eventually you will get slammed.
"So...you started off with very small size, much much smaller than you would on your normal trade." very true, that is the position building approach which is used by many big players. However, it is most widely practiced as a rationalization by small investors who don't understand stop loss orders and can't admit they are wrong. Brokers also love to ask their clients to average down rather than admit they gave a bad recommendation.
There is theory and there is practice. Theory (for example linear programming techniques that you can have with Excel Multisolver) can say what the best strategy is as long as you have a set of probabilities associated with the scenarios. The problem is - first that probabilities means repetition of the same scheme so is it a systematic strategy that you will repeat hundreds or thousands of time or just a one shot opportunity because of special situation - second in practice the probability is not well known especially when there is autocorrelations. So people prefer to use rules of thumbs sometimes it works better. Rules of thumbs nevertheless must not contradict probability law. Usually you will put the greatest size associated with the highest probability although it is unknown but qualitatively ordered. Normally you enter the market when you estimate that the probability is the highest so for the size. This is the case if there is no constraint of capital. But if the leverage is relatively high compared to capital then there is constraint and that can conduct to privilege rather the alpha risk (risk of losing money) than the beta risk (loss of opportunity) that is commonly distinsguished in statistical test hypothesis.
Look at the compound interest formula. What is the most important variable for appreciating capital? Time is. You cannot spend one minute not making money. Being in a loosing trade is a mistake. You made a mistake. You must save and use time. If you are wasting time; stop it. Now the lesser part, money. Your task is to make money. This is true in all systems. You always have alternatives for making money. Say there is only one stock or commoditiy in the world. Notice if You are holding it one way or another you are making money. If you notice you are loosing money under this circumstance, then reverse yourself. If this unigue thing is flat, then exit and bracket the next entry opportunity. You never have to enter a trade by making a decision. Let all your entries be ones where the market takes you into a trade. Dollar averaging down is a no brainer. Never even think about it you have other things to decide anyway. Dollar averaging up is a possibility and one only if you can't be making more money doing another stock or commodity. If there is another one, then you have to migrate to that opportunity. Don't worry excessively about the costs of doing business; there is always a lot of money to be made. The cost of doing business is just like a movie ticket. You have to pay admission.
Man, you guys really go off the deep end about all this shit. Harry, every time I read one of your post's, I start listing to one side which causes me to spill my drink on my crotch.
If the market will reverse it is better to average, if it will continue its trend is better to take your losses...