I've read many things about this strategy, and non of them were in a good light. Do any of you employ this strategy of averaging down, also know as "scaling". For those of you that do this, under what conditions?
It is useful to distinguish short-term "averaging-down" trading strategies from long-term (lifetime) "dollar-cost-average" investment strategies. If you believe stock returns have a positive expectancy in the long-run (read e.g. Jeremy Siegel's "Stocks for the long run"), and are willing to invest part of your income every month/year, then a dollar-cost-average strategy might be interesting to accumulate wealth over a 20-30 year horizon. If you're a short-term trader you won't benefit from averaging-down unless you have found some way to identify stocks with a positive expectancy in the short-run, which is extremely difficult. Without this ability, you'll run the risk of adding to a losing position that might never go up before the end of your trading horizon (e.g. a day, week, or month), and have to close the position with a big loss.
The problem with averaging down is that you might find yourself telling the market which way you want it to go... by buying while the price is dropping, for instance... instead of asking the market which way it is going already... Scaling is different from averaging down... when averaging down you keep buying {or selling} against the flow of the market, getting a larger position with a better average price... when scaling in on a trade you start with a small position and as it moves your way you add up, ending with a much larger position at not such a great price... but with the advantage of having the market flowing your way. Scaling out of a position is taking out your profits in small pieces to asure that you dont get out too early to take a big winner or too late and end up lossing it all back to the market.
Yeah, scaling is actually the opposite of averaging-down. Let's say a stock is dropping and you buy more to lower your average-cost. And it continues to drop and you lose even more money. Scaling is the opposite in that you're placing trades that's profitable. So as the stock drops, you'd be shorting it. And as it drops more and more, you're shorting more and more of it, thus making even more money.
Scaling in, scaling out, averaging in, etc is all described in Kaufmann's book. However the crux of the matter is that it has to be very tightly integrated with your system. Most of the methods will lower your P/F substantially, except with the "barrel position sizing" which will have slight improvement in net financial results with a slightly better P/F. First learn to trade with a single contract, then start playing around on a simulator to your hearts content with position sizing and do hundreds, if not thousands of trades. You'll soon learn that it is not really very helpful in intraday trading. And when you start in longer term trading then there is only one way to trade: scaling in but you'll need to know when to hold them, when to fold them, when to walk away and when to run. Good luck Holmes
Depends on the style. Averaging down in a trend-following system and averaging down in a counter-trend system is different.
I know that most people won't agree, but I do very well with "adding to a losing position." It all is what works with your specific trade. It seems to give me a much higher win/lose ratio, just the Lose IS MUCH BIGGER!!! than other wise. I usually end up with one bad day a month, which takes out a weeks worth of work. With a random distribution of bad days, some months I work for free, most months I do fairly well, a couple months I make a killing. Teh question that you need to ask yourself is can you handle the bad days/months?
Mike, With all due respect, with your strategy, you could very well hit a trade that you will never recover from. Unless, there is something else to the strategy, like max number of averaging down or something along those lines.