'Averaging down' presumes only going long. Whatever, 'averaging down' as a strategy, certainly for day trading, is the work of fools. Why not trade in the direction of the upswing or the downswing a market will demonstrate at any one time? I am not talking about scaling in and scaling out because very large entries, if not divided, may otherwise tax market liquidity with a temporary price disadvantage against you.
That's a good clarification. Averaging down as a method or strategy is not a good idea. Using instead as a tool for position entries is extremely beneficial. Anyone find it funny that 90% of traders think averaging down is the devil (because that's what new traders are taught), and 90% of traders fail? Probably just a coincidence. http://elitetrader.com/vb/showthread.php?s=&postid=1731642#post1731642
Perhaps LTCM, Victor Niederhoffer and a whole host of other tragic heroes, both recent and not so recent, should chime in with their opinions. And maybe averaging down should have its own slogan: "If you're gonna go down, you might as well do it in grand style."
Alright, for example if I was looking for something to short today as a breakdown candidate something like BLUD would work. I would be happy to short that at any price up to around 30.80. The stop would be the high at .86. Of course I have more rules about when to enter shorts based on market action etc, but that is an example of something where I would be willing to sell into a loser if I was following my rules and the stop didn't get hit. Weak stocks can be temporarily strong, and vice versa. The best traders sell into those situations for nice entries. When you are only willing to average up you never have a very good entry price, so I like to do both. Averaging down as a strategy on the other hand would require you to only take positions which are continuously going against you. Many of my trades never do, but the ones that do I try to take advantage of the situation as long as the chart is in tact and I'm trading with the trend. When I break my rules by trading counter trend I often get smacked around.
I would say that averaging down as more of a longer term stock strategy can work when using fundamentals and being able to take the loss at whatever price when needed. For example, you are averaging down, and get a margin call, that means that the market is going down, and you need to start selling at whatever price you can get, that is how the pros react whereas as a normal person will just sell enough of his winners to avoid the margin call and stay with his losers until he has lost all his money. You can also average into a position. Say you are planning to buy 1,000 shares total of a stock, but instead buy 500 shares today, if the stock pulls back, you buy another 500 shares in the future. In this case, you had a plan which is alot different from someone who bought 1,000 shares, sees the stock fall 3 points, and now decides to buy another 1,000 shares because he hopes it will go back up.
averaging down is a matter of prediction. this is why it fails. you predict that the market will eventually stop before you get creamed. this is absolutely stupid. averaging in, or scaling in is, by contrast a matter of reaction. say you enter 30% of your trade when new highs are made. this is not prediction and this is why it works. i'd say averaging in is the holy grail, but you have to know how to do it right!
and another thing: in order to scale in you have to be used to watcing pure price action. you can't scale in effectively by using indicators. it's just too late.