To Double Down or Double Up?

[daytrader2010]

I have seen a lot of losers who average down and then take some blow out losses.

I can only remember one really profitable trader who used this approach, and the only difference was that he had a range where he would average down, but if the market moved against him too much then he would reverse his position.
That's the really tricky part that makes it work.

 

[Wallace]

averaging down is rogue trading

if you do it once and win, that's the reason to do it again, creating the spiral
of reinforcement prior to an ultimate loss that may be catastrophic

how many times do you average down expecting a rally to new highs ? -
how many winning, losing trades have resulted from averaging down ?
wins justify averaging down, do losses stop averaging down ?
does averaging down create risk aversion ?
if you close a loss then it rallies to a new high from the new low do you say
'well if i'd just stayed in . . . '

" psychology of a rogue trader
• drive to succeed
• major “high” from generating huge profits
• management points to trader as an example
• expectations grow
• greatest fear is that of failure
• hide losses believing they can work their way out "
http://www.soa.org/files/pdf/2009-chicago-erm-rabinowitz.pdf

'Craving the High That Risky Trading Can Bring' some interesting points:
http://www.nytimes.com/2008/02/07/business/worldbusiness/07trader.html

if one averages down regularly it's become a trading technique - 2 points:
• if and when there's a loss, is it greater than having taken a first loss
• one's trading method is flawed if averaging down is part of one's method

 

[jones247]

Excellent suggestion by PocketChange...

Averaging down should NOT be done without hedging. The best way to hedge is with a long option position. I would use a delta neutral positioning. The strike price, whether atm or otm, will depend on the IV and my perceived direction of IV in the upcoming weeks.

Although there is a cost to hedge, gamma scalping helps to pay for it (as does otm short option position)... Nonetheless, there's no free lunch, as a collar position then limits your upside potential...

Dynamic hedging is really your best bet...

Walt

 

[DrEvil]

If you are risking say 0.25% of your account and average down to say less than 1% of your account then it's probably very profitable. Averaging up is better if you are starting with an initial risk per trade that is relatively high.