One of the best arguments against averaging, in my opinion, is that it weds you even tighter to that stock. You are making a mental effort to turn that position around. Every new purchase is an additional tie. If you had just bought a boatload of shares in the first place, would you stay in after a drop?? No. You'd be saying "Yikes! I can't let myself lose any more money here." And get out while you still could. The reason we average down is because we entered the position too early. We are afraid of missing out on that "great move" and took a chance, by getting in "just a little bit". We knew there was more cash/margin available "if needed" and hedged, by at least sticking a hand in the water. But.... that hand gets stuck on a "tar baby." I do think there can be some justifiable cases to average into a position. If it really is a long term hold... like stock in a quiet, flat-trending, profitable company that pays fat dividends, which you intend to view like CDs and not sell for months. Or if the drop was some kind of disturbance in that sector, which affected all stocks (including your "good holds") and presented an even better buying opportunity. But most of us averaged down for other reasons. 1) Trying to turn a loser into a winner. "See, I never was wrong!" 2) Trying to "get some money back" 3) Compulsively trying to find the bottom... "Aha! I finally found it! What a great trader I am!" 4) "It just doesn't belong down there. It'll be back to normal prices soon!" 5) "Surely it can't get any cheaper!" 6) Trying to save comissions, by getting a low basis, that you can sell all at once. How did I come up with these reasons? Ummmm.... I read about them somehwere.....
There were times when I entered a position and was proven wrong, plain wrong, and I got out. Then there were times that I entered a position prematurely or late and the first counter-reaction put me in the red. The latter example were times where I would consider adding to a position because the most optimal entry presented itself shortly after my initial entry. If the second entry proved wrong, then I was out as soon as possible. But most often the second entry was correct and profitable and I could close out the full position at a profit. One bad trade should not lead to another bad trade, nor should it lead to ignoring a good opportunity. The key is remaining level-headed.
Like most of the guys I would say it's not a good practice. I would not average down in against a trending market. A well known poster did it here last October when the market hit it's low and started going back up. He shorted QLGC and a few others and as the market moved up he shorted more until he was way over 50K to the negative. But I have made a lot of money averaging down but only in a side ways market or with the trend. In other words on pull backs. Or on a sudden drop on news. Recently I had it happen with LPNT it gapped down on 4-29-03 from 20.75 to 18.20 open. in the first half hour or so it dropped further to about 17.90 where I went long, after a short pause it continued falling until it hit 17.35 where I thought this was the bottom and kicked in with several thousand more shares, and once again after a short pause it fell to 16.55 in a flurry of activity and I picked up another several more thousand shares at 16.75. LPNT closed at 18.00 I sold a little short of the closing price with 2K to the good. I hope this helps answer your original question. I have done this several times mostly with positive results but this not something to do for new folks or anyone with too small accounts
I think it's OK to average down as long as you've planned ahead of time where you will add to your position and where you will exit the entire position if you're wrong. I've started using averaging down as a tool on some of my trades and it's been working well. The only drawback is that many times I'm right on the initial entry and I end up with a partial position on a trade that's going my way. The way I've been doing it like this: let's say a stock is correcting and approaching a support level at 40 that looks like a good entry point, but I'm not sure it will stop there and there is another key support level at 35 that I feel very strongly will hold. I may put on a partial position at 40, and plan to add some more at 35 if it continues to trade down. I would then use a fairly tight stop just below 35 for the entire position. Of course, you need to determine the total loss you are willing to take on the entire trade prior to putting it on, and you would want it to be within your overall risk parameters (i.e. risk 2% of total capital per trade). I think where most people get into trouble with averaging down, is that they haven't planned out the risk ahead of time, and they just keep adding in hopes that things will turn around and save them. I always write out all of my entry and exit prices and quantities ahead of time, and calculate the total risk in dollar amounts for each portion of the position, as well as my profit targets and the dollar amount of reward if it goes my way. Since I've started doing this (writing down risk vs. reward), my trading has improved dramatically.
I dont think averaging down is a good idea. I think Div Poacher and jack hershey made great points. If a trade is going against you, then it feels bad (hey, at least to me). It shakes your confidence. If you add more to a losing position, then isn't it just worse? Even if you had a good plan, if you have your confidence shaken, then it becomes more probable that you'd break away from the plan, because loss of confidence can make you irrational. Those other reasons mentioned by Div Poacher, I think, are the result of loss of confidence, stemming from a losing position. Also, having a losing position - boy, it gets to you. Well, at least it gets to me. I personally want my trading to be as stress-free as possible. I don't want to have losing positions, get stressed from it, and add more to the losing position, and have more stress. I wanna be happy. I agree with jack hershey, that time is important, and adding to losing positions can really lock you into that trade and make you miss other profitable opportunities (I've done this personally), and thus, lose time. I would add that adding to losing positions is bad because it locks up more of your capital. You can take the capital that you'd use to add to losing positions and put it into trades that would go in your favor, and is not showing you a loss. You have to bet in order to make money, and you can't bet unless you have money. Again, I've done this personally - I've missed great trades because my capital was tied up in a losing position (even though it did not hit my stop). my opinion. Jake
Depends on your method.. buying on retracements from the main trend, there's little chance you'll get the exact low. You may buy some at the 38% retrace, expecting that to be the bottom but it goes down some more. Buy some more at the 50% retrace, which does turn out to the be the bottom... or it could go down to 62%. At some point, you'll have to realize that this is no longer a retrace , but instead a trend reversal and then you stop out on everything. Don't believe everything books say about never averaging down. They write books for a reason. Risk control is key, you want to buy small enough portions where it won't hurt that much for price to go against you.
Bingo. Exactly. I only average down when a system has this idea built in. This means, among other things, that the addition is done before the position's original stop is hit, and the add-to portion has its own, even tighter stop. And while I agree in principle with the idea that there is an opportunity cost to having trading capital tied up in a position going nowhere, in practice the capital constraint rarely hits before risk considerations do, so the opportunity cost is usually nil.
For me, it's more a case of looking at where the trade is and what the market is doing RIGHT NOW. If I would enter the market for the first time with a larger position under current circumstances, even if I didn't have a position under water, then I would consider it. I look at each position with an eye to where it is this minute, and what the market is telling me now. It really doesn't matter to me where I got in. If it looks good at this level, under present circumstances, and meets my entry criteria, then I might add to the position. If it looks bad, then I should be out regardless of where I got in. It is immaterial where I got into a position, all that matters is what the market is doing now, and whether I want to be in it or not, and at what size, right now. Jessie
Sure I can see that. You are sitting with a stop in place and you have some reason to increase the position keeping the original stop. Whoa, there is a conflict of interest here. You should not be getting recommendations from Brokers. Hire your own Research, this in no place to be accepting freebees. If your broker is recommending trades, get another broker before he gets all of your capital. In the sense of adding to a loser. Don't. Adding to a winner only if it's the best opportunity. Seasonal Spread trading can be kind of like trying to catch the loss ness monster. We put a position on, like having a net floating on the surface of the water. When the seasonal breaks out, our net has um, and acts as an alert to average up. Some times when we are waiting for the seasonal, we can be stopped out of our earliest spreads. This is no reason not to put on the later ones at a lower price. The Seasonal thrust just has not appeared yet. What can happen with spreads is that we may be experiencing drawdown on a spread. Later another similar spread (the same spread with different months) comes up. Maybe originally the far contracts did not have enough liquidity, now they do. So, we could call it a new position, but really, we are averaging down the same spread (Bull or Bear) into the Seasonal trend. It is the same spread but it may expire at a different time so the distinction gets a little blurred. The thing is we are pretty sure the forces of supply and demand are out of balance and are about to readjust. We just do not know exactly when. If it's a little later maybe from a lower value, we do not want to miss it. So the situation is we may have gotten in too early because the seasonal pattern is historically late. Even if the first spreads run out of time. Averaging down is a way to buy more time, Averaging up is a way to buy more profits!