Tell me why averaging down is a bad idea .

joker542

joker542

Ok here my trading system outline,
look for potential reversals . wait for it to go into oversold zone.
keep adding similar positions in oversold zones like 3-4 times max. Then for the last position added , put stop loss of like (.3)-(.5 )%. and if stop loss is hit then probably I am wrong about reversal and I get out of trade.
 
Just remember - always prepare for the unexpected...

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"The cash-strapped Wall Street investment bank Bear Stearns was rescued from the brink of collapse tonight through a takeover by rival JP Morgan Chase for the rock-bottom price of $236m.

After a weekend of frenetic negotiations, Bear Stearns' board approved a stock-for-stock buyout at a valuation of just $2 per share. In a sign of the desperation of Bear Stearns' plight, the deal is at a 94% discount to the bank's closing share price of $30 on Friday night."

https://www.theguardian.com/business/2008/mar/16/creditcrunch.useconomy3
 
joker542 said:
Ok here my trading system outline,
look for potential reversals . wait for it to go into oversold zone.
keep adding similar positions in oversold zones like 3-4 times max. Then for the last position added , put stop loss of like (.3)-(.5 )%. and if stop loss is hit then probably I am wrong about reversal and I get out of trade.
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You'll likely get away with this strategy most of the time, but the question is... How much do you lose when you get down to your "throw in the towel stop"?

There is a famous picture of Paul Tudor Jones's office wall with a framed post, "Losers average into losers".

Suggest you learn about "Price TA". That way you won't be tempted to "average in" on large market moves against you.

Said another way... If I were looking for a money manager and one told me his strategy was to "average down", I wouldn't hire him.

FWIW....
 
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joker542 said:
Ok here my trading system outline,
look for potential reversals . wait for it to go into oversold zone.
keep adding similar positions in oversold zones like 3-4 times max. Then for the last position added , put stop loss of like (.3)-(.5 )%. and if stop loss is hit then probably I am wrong about reversal and I get out of trade.
More...

this will not work... you can back test but the results will not be better than simple buy and hold.
 
_eug_ said:
It works great... until you blow up your account on the one trade that doesn't come back. Your chart reading SKILLZ need to be impeccable and need DEEP pockets to do it, especially in futures.
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You not only need "deep pockets", you also need a false sense of your analytical abilities and a HIGH LEVEL OF STUPID!

You only average into a loser when you are convinced that YOU are right and the market is wrong (that and when you are DESPERATE "not to take a loss on this trade"). STUPID! The market is ALWAYS the final arbitor of price. Disregard that fact at your own peril.
 
You're just trading win ratio for expected win/loss this way. I.e. you will win more often but the size of the losses will magically cancel out the benefit unless there's more to it.

Now, if the underlying phenomena you're trying to capture has multiple possible entry points at subsequently worse prices, this strategy may actually do better than a single entry. However: Unless this is a completely automated (and carefully backtested) strategy, stay away from this. Even then, chances to have this working are slim; after all the first entry is then effectively a suboptimal one that will be underwater for a while, that would have been better later.

In its extreme form: https://en.wikipedia.org/wiki/Martingale_(betting_system)
 
joker542 said:
Ok here my trading system outline,
look for potential reversals . wait for it to go into oversold zone.
keep adding similar positions in oversold zones like 3-4 times max. Then for the last position added , put stop loss of like (.3)-(.5 )%. and if stop loss is hit then probably I am wrong about reversal and I get out of trade.
More...

You left out two key factors, your time frame and what you're trading.

I don't have a problem doing this intraday with stock indexes or something like bonds, FX or even oil. They tend to mean revert during the day at some point unless you are dealing with a one way runner type day, in which case you are screwed. I wouldn't do it with something like an ag commodity where you can get limit locked. Individual stocks can be tricky, as they have a tendency to close at extremes if news is involved.

I also wouldn't do it on a longer term position. The reason is you are likely to be dealing with a more serious problem than just some intraday over run. You are much better off pyramiding into winners.

The key with an intraday double- or triple-up is to give it room to move before adding. You want to make your last add very close to your stop, so that you are not risking much on it. The real key to this technique however is you must be able to kick out the whole position if that stop level is broken. The market is telling you that you're wrong, so eat it.

The other key factor is exiting. It's tempting to want to hang on if it reverses because you have a good cost basis at that point. But markets that go down hard then close at the highs are rare events. I think the safer approach is to exit the whole thing if you get past break even. It's mainly a technique for turning losses into small winners.
 
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