It all depends on strategy and type of trading being done IMHO. People should understand the fat tailed distribution found in all mkt price data across all timeframes, and realize those fat tails is what makes averaging down dangerous if done improperly. If mkt data conformed to standard distribution, averaging down would always work. Have to decide where you are going to make and lose money = the fat tail, or the bell curve. Each has its benefits and weaknesses. http://www.elitetrader.com/vb/showthread.php?s=&postid=2311344#post2311344
Averaging down can be risky business. But if you insist on doing it, here are several rules which I believe can help you avert disaster: 1) make sure your market is normally a mean-reverting instrument such as an index or broad ETF 2) make sure to scale widely enough to make your 2nd unit extremely likely to show profit (I do not recommend averaging down more than once per trade) 3) have a pre-planned stop loss for the entire position 4) exit before your stop is hit if the market shows evidence of runaway momentum against you (news shock, etc.) 5) you are trying to pick a top or bottom, so once you are green make sure you hold some well past your B/E to help counteract the large losses you will occasionally experience. You do not want to be averaging down into huge unrealized losses and then exit with just a few ticks profit ... this will kill you over time. Edit: I have mentioned this before - several S&P pit traders I know do average down regularly. (They also average up.)
I was being rhetorical, I trade that way manually and am looking to add more automation. I don't worry too much about edge saturation because it's too hard to teach and requires too much feel on the risk management side when it's not working right. I loved your answer, ammo!
---------------------------------- HERD member talk. The HERD rule is simply, "Never add to a loser" .... ditto for everything else in life (except for supermarket shopping and fat chicks. ) But by definition the HERD cannot TIME. Timing is taboo at ET, yet it is the only thing that could eject a member out of the HERD and save him= individualize him. Timing is a skill, but the HERD by definition, can only REACT=FOLLOW, so expect 1000s more threads on STOPS, TP et al ad infinitum. Watch ET in the picture below. Only the first jumper CAN be converted to an individual but even this would be hard work due to the fact that he never sees the crocs in the first place until too late. Uploaded with ImageShack.us
I got a suggestion: don't trade it? Theres empty coke bottles worth 5 cents in garbage cans, do you pick these up all the time as well?
May be its just me â but I would be Thanking NYOB and Ammo about nowâ¦. eta - Working your way out of a losing position is possible - worth understanding what was posted for a couple of reasons... RN
Deadbroke is a much better read. Ammo and NYOB are blowups around the corner. Traders most valuable edge is timing, sadly Many traders aren't even proficient in the basic "requirements" to make it in the business. So they average down, because they are too lazy to past basic bootcamp.
Like others have said, it depends what the market is and what it's doing. If it's chopping averaging down can work, if its trending averaging up can work. If only it was easy to figure out whether we will chop or trend on any given day. Since a lot of people don't fade the chop averaging down is usually not a good strategy for them. If you initiate a trade and you start losing on it immediately (not just a few tics) what does that tell you about the trade? Either you're early or wrong. If you're wrong you should be getting out not getting deeper in. If you're early you wont know it until after the fact so why increase your risk on a trade that hasn't proved itself yet. You're putting yourself in a bad spot psychologically by taking a loser and making it a bigger loser, with a chance to get even bigger. It's better paying up a few more tics and being right on the trade, rather than getting a better entry price that ends up as a losing trade anyway. The major problem I've found with averaging up in the index futures for example is the fact that at the start of most good trends the market will have strong retests that go to your entry or worse, so if you add on the first move higher(lower) your new higher(lower) avg entry will put you in a tough spot on that first retrace.
Please keep an open mind. I could give many examples of people blowing up that don't average down also. I know all the books teach to not average down, but many great traders average down (aka scale in around support and resistance levels) The key is still to keep the total average risk under 1 or 2 % of your total equity. Not sure how you can blow up if you average in a couple of times and your total risk for the position is kept under 1%. Trading is a great paradox where what appears wrong is sometimes right and what appears right is sometimes wrong.