Talion Law: An eye for an eye. With due respect, will you accept calmly if I break one of your arms? Certainly not. Your frustration will not make you stay calm until you break my arm or even more, two arms. It's exactly the same thing. When you're facing a loss you're not only want a break even at a point where your first buy but also you want a shortcut. You want that stock to rise up to somewhere below your first buy that can give you break even or get some gain.
It also depends heavily on market conditions and it doesn't take into account periods of extreme economic depression or recession. The "always goes up" thesis may be true if you take into consideration the market as a whole but for individual stocks it's absolutely baloney. Also time consideration is a huge factor. Most people don't have the patience to let money sit for decades.
Some FX traders and system sellers were doing great with the "averaging down/stop losses are stupid" approach for the EURUSD. But a few months and margin calls later, it doesn't look like such a great idea any more. While I'm not a big fan of dollar cost averaging for stocks or stock indices, it works relatively well for the very long-term. It's a different animal than cost averaging a leveraged instrument, however.
Even with the deepest of pockets.. ie the feds and the bailout which is essentially averaging down AIG and the banks... We may get lucky or we go bust. As a trading strategy... Can produce better than 90% wins but the i10% you lose can wipe you out. Don't focus your plan on the 90% wins... focus on different ways to hedge and reduce the 10% losers and you can develop a strategy that can work within a trading range. ie. 5 strikes, 25 points etc... once your range is exceeded all bets are off. Success of an overall averaging down strategy depends on how many steps you add. your add increment, how you calculate your entries and exit points... and most importantly how you hedge your runaways. Below is a failrly simple strategy for averaging down ES in a trading range of 5 strikes from entry point. Run from the same entry signal both long and short in two seperate sub accounts. Shortbot: Entry: Short 1 at market Step 1: add 1 at (market + 5 points) exit at 1 point. Step 2: add 4 at average cost + 7.5 points Exit 1.5 points Step 3: add 12 at average cost + 7.5 points Exit 2 points Step 4: add 36 at average cost + 7.5 points Exit 2 points Safety Stop at Average cost + 5 points Exit 2 points: Longbot: Entry: Long 1 at market Step 1: add 1 at (market - 5 points) exit at 1 point. Step 2: add 4 at average cost - 7.5 points Exit 1.5 points Step 3: add 12 at average cost - 7.5 points Exit 2 points Step 4: add 36 at average cost - 7.5 points Exit 2 points Safety Stop at Average cost - 5 points Exit 2 points: Maximum 54 contracts and a trading range of 5 strikes up or down. Maximum risk per side is $10K. Problem is when 54 contracts hit the saftey stop you take a $10k hit. To reduce the hit you can hedge using options that cover a portion of the loss when the market moves 5 strikes. You are not trying to cover a set amount of contracts with these options but a dollar value of approximately $5K to reduce the runaway stop loss. If you buy $10K of 5 point options that are 10 - 15 strikes OTM then when the underlying trade moves against you and you hit your safety stop the options can be liquidated to offset 50 - 75% of the loss and the counter bot should profit enough to cover the remaining. When all stays inside your trading range your making decent $ on all contracts and options both ways. Another method far riskier to hedge the risk but more inline with trend trading is to reverse before step 4 and go 54 contracts counter with a 2 point exit. Yet another method is to jump steps and add to the position size for the counter tradebot that is winning. Problem is when the market changes this bot will safety stop sooner. Bottomline is averaging down with a plan is only as good as your plan to mitigate the inevitable losers. You can make a lot of cash but you need to be extremely disciplined to live to trade another day. Its all dependent on your ability to control and execute your plan with precision. The magic formula is everchanging and elusive but seems to be a bit of luck and a combination of the above.
averaging trading is ok. I did lots of averaging trading, most are averaging down, some does not work, some works with massive profit. like today's CI, when I saw 10 under, I started to buy it every 0.3 cents down until it start to move up. it turns out it is a big winner. or like several days' SVNT/HIG, when SVNT dropped to 4 under, I started to buy it, and HIG started to drop to 9 under, I started to buy it, they all turn out to be big winner. of course you need a plan, and you need steel nerve to bear the about several minutes's temperary paper loss or one day waiting. the unscussful averaging down trade I did this year is BSC, I lost because I did not realize I withdrewed money from my account, my averaging needs exceeded my margin requirement, and I get margin call, actually it is a very profitable trade if my firm did not kill my trade always remeber "panic market rallies", like CI, I suspect lots of short sellers get killed today, I feel their pain and enjoy my ride to 18
Averaging down is for those who lack the chart reading skills to enter at key areas and/or the correct trading plan and/or discipline to exit when mistaken. Everything else you throw at it, it's but an excuse due to failing to accomplish the above. TV
I believe that it is rooted in the Buy & Hold mentality. If I bot it at price X and it will go to price X+Y, then it is an even greater bargain at price X-Z. I always think of averaging down in terms of buying a greater ownership interest in the Titanic after it hit the 'berg.
<i>"Averaging down is for those who lack the chart reading skills to enter at key areas and/or the correct trading plan and/or discipline to exit when mistaken. Everything else you throw at it, it's but an excuse due to failing to accomplish the above."</i> Absolutely. Results from averaging-down tactics gives the feedback and validation struggling traders crave. They almost never blow out right away. Regardless of how painful the unrealized loss was during adverse moves, end result is some kind of net profit at the end of most "trades". There is the validation that it works. Profitable trade after profitable trade. Real money in the account. Who can argue with that? More importantly who would WANT to argue with that? After all, instant results = positive results is what every aspiring trader craves. And then there it is... right on their account statement in black & white. Of course the truth is that scale-trading is never successful over time. There is not one person in our profession who has or ever will make that work consistently for years. Why? Because average-down scale traders are always working scales = levels based on price action that just ended. Eventually the next scale averaged into will hit changing market dynamics and the big loss will wipe out all those small gains. Once the scale trader hits a max loss or two, fear emerges. They realize how much pain it took to ride thru all of those unrealized big losses for small gains. All that effort... gone. Wiped out. Back to square one. That's where the discipline to stick with a (flawed) plan breaks down. The next time a big loss looms, stops are pulled and greater pain is ridden out. Beats the reality of 19 days' profit erased by 1 day's loss, right? Then comes the day or days that blows their scale(s) out to kingdom come, and it's game over. But... the biofeedback of real money in an account day after day cannot be ignored. Surely there is a way(s) to overcome the inevitable huge loss. Figure that one out, and this trading stuff is easy! Free money, never have to worry about learning price direction, etc. It is impatience = laziness which hooks someone into the allure of scale / averaging down trading. It is the psuedo-success of small cheese rewarded before the sledgehammer hits that keeps them trying to steal bait from the trap. Sadly, there is no way possible to dodge the sledgehammer forever. If there was, someone else would have figured it out and we'd ALL be playing that game for $$millions. Averaging down = ultimate failure in the end. Every time, no exceptions exist. Just give it enough time and that universal law will fulfill.