Adding to Losing Position or Averaging Down Cost ?

WinSum · Feb 28, 2003

A good trader knows that he should not Add to a Losing Position. However, I have seen good traders also use the technique of "Averaging Down Cost" to trade out of a losing position into a winning position.

These two caveats are diametrically opposed to each other. Which one is the better choice ?

My thought is in a trending market, always use the "Do not add to a losing position" rule. However, if the market action is in a whipsaw range, then using the "Averaging Down Cost" technique to trade turn a losing position into a winning position is a better choice.

What have your experience been with these 2 trading techniques and how do you determine when to apply them ?

daniel_m · Feb 28, 2003

tough question...

the obvious answer is never do it, but things are rarely so simple.

i used to do it (average down) if i thought i got a pretty bad entry, but i still liked the trade. paid off handsomely on some occasions, killed me on others. overall, it was a losing experience.

i can imagine it would be a worthwhile tactic on some occasions, and for some trading styles, but i really don't know when/what those would be. the big problem is that as it moves away from you, it would always look more attractive...

NorskTrader · Feb 28, 2003

It's interesting that should ask this, because I've recently begun researching this question, looking at it in the context of a particular system I've been devising. Until I expand the research to other instruments and deeper historically, I'm not entirely confident that what I've seen so far isn't just a function of the particular anomalies of the dataset I've got so far (about 330 instances of the initial setup being triggered, with another 50 or so providing opportunities to add).

But, that having been said, it appears that under certain technically defined conditions, pullbacks against this system's initial entry trigger, while somewhat infrequent, have been a wonderful gift, and additions to the initial position during those pullbacks have enjoyed vastly better performance on a reward-to-risk basis. So I'm motivated to continue pursuing this line of research and to see whether these patterns also appear across more instruments and a greater variety of general market conditions.

In fairness, I should also mention that I have included a safeguard in this system, which helps on the risk side.

Ron In-a-sauna · Mar 1, 2003

def. depends on situation. i.e pairs you always do it...and newbies will always put another position on too soon i.e every 10 cents whereas i.e maybe i get trapped and it gaps down 1/2 point or so, ill take a flyer and buy if it looks like a cleanup but definitely not hanging o to it too long....

rs7 · Mar 1, 2003

Quote from daniel_m:

tough question...

the obvious answer is never do it, but things are rarely so simple.

Overall good answer Dan.

As we all know, it is wisest to never say never.

While averaging down (up on shorts) is well accepted as a low percentage play for daytraders, under certain circumstances, it becomes irresistible.

The more interesting question to me would be this: does one average against actually with the objective of turning a loser into a winner, or to try and turn a loser into less of a loser.

It really is a matter in the end of where your buying power is best used. So for the most part, it makes more sense to take the loss, or to keep the losing position in the hopes of it improving (what you would expect the price action to occur if you were to add to a loser anyway), and use the BP you would commit to the loser in an entirely different trade, which is more appealing at the time. Averaging against is really a "revenge" trade. Not a good approach.

Of course we all do it on occasion anyway. Sometimes we get lucky. More times than not we don't. The biggest problem I have seen with traders is they "discover" averaging against, it works for them at first, and they get into a losing habit.

When I worked at a large firm (Schonfeld), it was very strictly forbidden for any trader who traded less than (if I remember correctly) 10k shares or so to average against. Things may have changed since...that was quite a while ago. But the basics of trading have remained pretty much the same forever.

Without a truly compelling reason (and they do exist), it is not a good strategy. Do I do it on occasion? Guilty! Am I comfortable with those trades? Never!

Just last week I did it big time one day on a short of MSFT. The guys in the chat room (nitro and optional777 come to mind) may remember my agony. I ended up making money on the trade. I also was so miserable I felt guilty for contaminating the chat room with my anguish. Not fun!

Peace,

Rs7

harrytrader · Mar 1, 2003

I will give the impression to some of you who reads me of repeating the same thing one hundred times but I will do it again until everybody get accustomed to the idea that WHAT IS IMPORTANT IS THE FRAMEWORK

One thing that is GOOD inside a FRAMEWORK can be DEVASTATING inside another FRAMEWORK. Because each framework has IMPLICIT CONTEXT that is like the backbone of your skeletton: you don't see or express it but it is nevertheless the essential part of this skeletton ! So when one uses "Averaging Down Cost" strategy what's the IMPLICIT CONTEXT ? It is that one knows for sure what's going on about the fundamental. You can't assess the fundamental for every asset. For example fundamental for commodities is very important because they are real physical products whereas fundamental for techno stock well I don't have to depict you the difficulty. That's why "Averaging Down Cost" strategy is more often used for commodities because the price of wheat cannot reach 0 whereas the price of a techno stock can just do it. Another implicit context is that it is all but the contrary of market timing so you will have to hold the position for a long time and suffer margin calls if necessary. So the leverage used must be carefully appreciated and be much less than in a framework that uses market timing. Thta's why the capital necessary is higher than with the market timing framework that's why the Big Commercials use it against the small speculators. In this framework time is rather your friend whereas it is your ennemy in the market timing framework.

Not only the Big Commercials have the money power with them but if necessary they can cheat with the help of higher margin call - let's remark that even a real Casino can't change their rule like that to wash out some players

(also remember the virtual stock market whith restart game rule: http://www.elitetrader.com/vb/showthread.php?s=&threadid=13378&perpage=6&pagenumber=1 ):

http://www.fallstreet.com/feb1403.php

Originally developed by the Chicago Mercantile Exchange, âSPANâ software is designed to quantify (correlate) price to risk in the commodities markets. Apparently, and confirming this is not easy, NYMEX plugs contract data into this program to determine if margin requirements need to be changed.

On Thursday February 5 at approximately 5:08 PM, NYMEX stated that âGold futures margins will be increased to $1,500 from $1,000 for members, member firms, and hedgers, and to $2,025 from $1,350 for speculative customers.â What these new margin requirements did â again, difficult to confirm (until today) - was force many small speculators out of the market because they could no longer maintain margin. As for the larger players â the commercials/hedgers -- margin is not that much of an issue when you have Greenspan in your corner.

Quote from WinSum:

A good trader knows that he should not Add to a Losing Position. However, I have seen good traders also use the technique of "Averaging Down Cost" to trade out of a losing position into a winning position.

These two caveats are diametrically opposed to each other. Which one is the better choice ?

My thought is in a trending market, always use the "Do not add to a losing position" rule. However, if the market action is in a whipsaw range, then using the "Averaging Down Cost" technique to trade turn a losing position into a winning position is a better choice.

What have your experience been with these 2 trading techniques and how do you determine when to apply them ?

omcate · Mar 1, 2003

Quote from WinSum:

A good trader knows that he should not Add to a Losing Position. However, I have seen good traders also use the technique of "Averaging Down Cost" to trade out of a losing position into a winning position.

These two caveats are diametrically opposed to each other. Which one is the better choice ?

My thought is in a trending market, always use the "Do not add to a losing position" rule. However, if the market action is in a whipsaw range, then using the "Averaging Down Cost" technique to trade turn a losing position into a winning position is a better choice.

What have your experience been with these 2 trading techniques and how do you determine when to apply them ?

IMHO:

Trading is an "Art". Hence, there is no rule that will always work. There were situations that I earned big money by averaging down. But this strategy has also cost me dearly in the past. There is no simple answer. Similarly, should a trader buy at the pullback or at the breakout ? Should a trader buy low and sell high or buy high and sell higher ?

I *** THINK *** it depends on the personality of the trader, perception of the market condition, maximum tolerance for losses, etc. Maybe that is why trading is never boring to me. The market always manages to surprise and humble me. However, if I change my game plan due to greed or fear, I usually lose big.

bone · Mar 1, 2003

I used to average extensively when I traded for a huge energy desk - but we had exact price bounds we were dealing with. In other words, I was only too happy to make or take delivery of many many many NYMEX or OTC contracts at certain price points. I rarely did, but our trading positions reflected a strategy by the Company regarding our cost of business. Our dynamic hedges became fantastic long-term trades - if they didn't, we executed the underlying because we could live with the cost at that price.

Flash forward years later - as an individual speculator, I have no cost of doing business (unfortunately-Sigh, what an edge that is!). Just pain and pleasure points. What am I willing to risk and at what price poitn and timeframe.

illiquid · Mar 1, 2003

I would think that for the vast majority of individual traders, averaging down is the leading cause of blowing out one's account. To eliminate this strategy (perhaps a better word is "habit") seems well worth it even if it means giving up some big gains.

I look at it this way: for the price of another round of commish and perhaps some slippage, by keeping my stop in at all times I am reinforcing discipline and maintaining objectivity -- otherwise, once you average down once, doesn't it follow "logically" that you should keep avging the further the position goes against you? If it was cheap at 45, it looks even better at 43, now look, its at 40 -- where does it end? (SYMC anyone?)

Why not keep your stops, then after they are triggered, if you can re-enter your position at a better price, then double up, but maintain that stop at all times. Repeat if necessary. Think of doubling or tripling down as a reward for keeping your discipline, knowing that your chances of blowing out on a single trade are greatly reduced. If you can only re-enter at a worse price than you were stopped out, just stick with your original position size.

harrytrader · Mar 1, 2003

>Trading is an "Art". Hence, there is no rule that will always >work.
Rule by definition never always work, if they always works they should be called Law.

>There were situations that I earned big money by averaging >down.
Of course if not so why would be the question

The problem is do you win CONSISTENTLY (on average) by doing so and not only sometimes.

>Similarly, should a trader buy at the pullback or at the >breakout ?
>Should a trader buy low and sell high or buy high
>and sell higher ?
It will depend on "this" trader's framework. Will he be able to judge that it is a breakout or a pullback ? He can do both if he has the framework to judge if not so he shouldn't trade at all. A trader without any framework is just a gambler.

Quote from omcate:

IMHO:

Trading is an "Art". Hence, there is no rule that will always work. There were situations that I earned big money by averaging down. But this strategy has also cost me dearly in the past. There is no simple answer. Similarly, should a trader buy at the pullback or at the breakout ? Should a trader buy low and sell high or buy high and sell higher ?

I *** THINK *** it depends on the personality of the trader, perception of the market condition, maximum tolerance for losses, etc. Maybe that is why trading is never boring to me. The market always manages to surprise and humble me. However, if I change my game plan due to greed or fear, I usually lose big.