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Thoughts on Averaging Down

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#1 SideShowBob



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Posted 28 July 2004 - 08:00 PM

I came across a system recently on Wealth-lab.com that is very similar to the RSI system from VTOReports (http://www.vtoreport.com/rsi.htm) but has an additional feature:
- if the NDX drops 5% from the initial buy, add a double position
- if the NDX drops 10% from the initial buy, add another double position

Theoretically if you buy 1 NDX futures contract, once the NDX drops another 5% you'd buy two more contracts, then two more at a 10% drop, and at the end you're holding 5 contracts. I suppose you could extend it to 15% or even 20%.....however maybe at 15% you'd be better off cutting your losses....and explaining to your wife why you'll both be living out of your car for the next few years.

In any case, the system actually does very well despite most advice I've seen which is to never add to a losing trade. While I can see the logic behind that, at the same time if you have a system which works well doing this I can't think of a reason not to do it. Of course some event could come along and you could get creamed in a crash, but the system didn't do too badly even after 9/11 (you can see the results of the system by clicking on and then entering ^NDX as the symbol, or QQQ, or any Yahoo stock symbol). this link

Since many traders here were trading before I was born I'd be very interested to hear your thoughts on this -- is it a case where conventional wisdom (don't add to losing positions) is wrong, or is the good performance here just a fluke? Personally I tihnk it's not a bad idea, as long as you don't try it with an individual stock. An index sooner or later will bounce even if it's just shorts covering -- if I were short QQQ I think I'd at least lower my exposure somewhat after a 10% move in my favor -- I know I should let my winners run but those short covering rallies during bear markets can be fierce....


#2 SideShowBob



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Posted 28 July 2004 - 08:02 PM

Sorry -- the link ended up at the end of the third paragraph....anyway the "this link" link goes to the web site where you can see the system results by plugging in stock symbols.... SSB

#3 Porter



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Posted 28 July 2004 - 08:08 PM

The system will probably work well with stock market indices most of the time. But I doubt it would work for Notes or commodities. That is because the stock market tends to be a reversal system. But the once in a lifetime drop, such as in 1987, can cause a severe drawdown. Porter

#4 eminimee


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Posted 28 July 2004 - 08:19 PM

System may work but would you sleep? Averaging down = no Z's squared

#5 SideShowBob



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Posted 28 July 2004 - 08:53 PM

System may work but would you sleep?

Averaging down = no Z's squared

I have two small kids, I don't sleep anyway :blink:

However, I see your point. I don't think I could double down unless I was in a very small position to begin with......but the system is good!!!!!

This does get me thinking though -- why not "double down" with a call option instead of actually opening a double position. Especially in a situation where the market is declining so quickly I'd bet calls would be selling pretty cheap....anyway that's something to consider....that also has me thinking that maybe a better way to trade the HiLoLimit system I posted about last week is to buy a call instead of QQQ/SMH/ONEQ --especially with implied volatility near multi-year lows.


#6 vitaminm



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Posted 28 July 2004 - 09:53 PM

Dollar cost averaging may work better in bull market but not in bear market.

#7 Rogerdodger



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Posted 28 July 2004 - 10:21 PM

Have you ever tried that system at a casino? It's called the "Martingale system."
That is a system where you double down after each loss until you win.
I tried it once and made several hundred bucks playing blackjack one evening. Then I went home and played it on a computer system. It is a winning system UNTIL you get a string of losses which will wipe you out in no time. That is, by the way, why there are table bet limits. Casino's don't want someone with deep pockets doubling down until they win. In just 10 losing hands with a $5 bet you lose: $5, $10, $20, $40, $80, $160, $320, $640, $1280, $2560 = $5115 in losses just to win $5. But the table limits a $5 table to $500 max bet. That's only seven losers in a row.
I did it once at roulette playing RED or BLACK beginning with a $1 bet. It is very easy to lose $100 beginning with only a $1 bet and doubling down after each loss.

#8 vulture



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Posted 28 July 2004 - 10:32 PM

Doubling down with options would only be feasible with far dated options (ie back months) since you would have less gamma sensitivty and the theta decay would be minimized over a much longer duration till expiration. Perhaps the upside to using options would be psychological since you could use the leverage of options to average your cost over a greater range in the underlying. At the same time, I know from experience that once options begin to collapse in conjunction with an adverse move in the underlying, it typically takes a significant move in your favor in a short period of time to recover anything from the purchases. Anyway, try plotting it out paper with options with around 3 months till expiration and let us know how it looks...

#9 bullshort



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Posted 28 July 2004 - 10:58 PM

I did it once at roulette playing RED or BLACK beginning with a $1 bet. It is very easy to lose $100 beginning with only a $1 bet and doubling down after each loss.


With all due respect, I totally dissagree. IF you use a "stop," it's not only not very easy to lose $100, it's darn near impossible. If the stop is, say 5 losses in a row, and at that point you go back to your $1 bet, the roulette wheel would have to roll 19 blacks in a row for you to lose $100 (assuming you were betting on red). I suggest that is not "easy". Boring to play that way, but the odds are you will win, not a fortune, but you will win.


Do that four more times and you lose $124. That's 20 losses in a row. It can happen, but it's not easy.

I use averaging in trading futures. I am amused by the conventional wisdom that disdains this methodology. If used with a stop, it works fine for me.

#10 Sentient Being

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Posted 29 July 2004 - 12:01 AM

I saw a guy keep adding to a penny stock as it collapsed until the penny stock folded and he was wiped out. He was going to make a fortune, instead he more or less lost his entire trading pile. Seems to me that people start adding on when they should be stopping out, but some of you are talking some very sophisticated games here. I wonder if the real bottom line is that there are all sorts of way to skin a cat if the risk/money management is sound.
In the end we retain from our studies only that which we practically apply.

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