Tired of people downplaying averaging down

Hard to disagree with one of the greatest ones of all time vs couple of aficionados in ET.

Harsh but the truth.

 

there's no need to hash, we just join here to discuss about all the thing related to trading so I think we can gain more experience than we have

 

Ernie Chan who wrote the book "Quantitative Trading: How to Build Your Own Algorithmic Trading Business" had a blog post on this subject a few months back.

Easy to find the blog post and the underlying Ron Schoenberg and Al Corwin research by searching for the title. The blog has some further discussion on the subject.

Note that the profit target of 3 is arbitary and not relevant to discussion.
If you let X be the evaluation price, the profit equations become
A) (X-2) + (X-1)2p
B) 2(X-2)
C) (X-1)4p
In this case A < B when p < (X-2)/2(X-1) and A < C when p > (X-2)/2(X-1)

 

“I have warned against averaging losses. That is a most common practice. Great numbers of people will buy a stock, let us say at 50, and two or three days later if they can buy it at 47 they are seized with the urge to average down by buying another hundred shares, making a price of 48.5 on all. Having bought at 50 and being concerned over a three-point loss on a hundred shares, what rhyme or reason is there in adding another hundred shares and having the double worry when the price hits 44? At that point there would be a $600 loss on the first hundred shares and a $300 loss on the second shares. If one is to apply such an unsound principle, he should keep on averaging by buying two hundred shares at 44, then four hundred at 41, eight hundred at 38, sixteen hundred at 35, thirty-two hundred at 32, sixty-four hundred at 29 and so on. How many speculators could stand such pressure? So, at the risk of repetition and preaching, let me urge you to avoid averaging down.”

--Jesse Livermore

 

Its not the strategy that is the problem, its the mentality. The mentality behind averaging down is increasing risk as losses increase because a bigger gain is required to "get even". I call it a martingale mentality/strategy.

And even traders that don't average down still suffer from this martingale mentality/strategy.

Every time you don't cut a loser when your system tells you - that is a symptom of martingale, every time you start trading more when you are down that too is a symptom of martingale mentality.

So abandoning averaging down as a strategy is only the first step in abandoning the martingale mentality behind it.

The next step is honoring every single stop, and never increasing frequency of trades in draw downs. Also it is a good idea to reduce size and frequency of trades in draw downs. This is an anti-martingale mentality.

Martingale significantly increases the risk of ruin. Anti-martingale guarantees that you will never face ruin - it is the holy grail.

The above facts have been scientifically verified and proved over and over again for decades.

But as humans we are hard wired to pursue martingale strategies as nothing activates the reptilian brain more than losses and risk, because we feel threatened by losses however small. And the fear triggers cognitive dissonance, and stress responses then all the sudden you have lost touch with reality - this is not the right mentality needed to protect/grow capital.

 

The soros's of the world dont need to watch the risk because they trade with insider info... they know what is planned...