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Thoughts on Averaging Down


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#11 outsider

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Posted 29 July 2004 - 12:34 AM

Averaging UP may be more reliable. Gary Smith, Senor and others seem to do averaging on the buying and/or selling ends. Gary adds purchases slowly as price RISES and comes out fast at 2% declines on his narrow channel upcharts. Senor seems to sell out in big portions as profit targets are met. Momentum seems to be more reliable but contrarians averaging down are more likely to hit it BIG or lose everything.... Can you catch a falling knife? etc. Out

#12 capitulation

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Posted 29 July 2004 - 02:22 AM

40 Bits of Trading Wisdom - Bit #25 Averaging down on a position is like a sinking ship deliberately taking on more water.
Learn the art of patience. Apply discipline to your thoughts when they become anxious over the outcome of a goal. Impatience breeds anxiety, fear, discouragement and failure. Patience creates confidence, decisiveness, and a rational outlook, which eventually leads to success. -- Brian Adams

#13 vulture

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Posted 29 July 2004 - 02:26 AM

I agree with Porter's comments that averaging into positions is really dependent on the markets traded. Stock indicies, in general, will be a bit more "forgiving" as far as scaling into positions assuming that there is a definable range to work with and one is not averaging down or up in the face of a strong trend. Bonds, grains, perhaps currencies can be a much dicier prospect perhaps because the speculators in those markets have a different agenda or the action is more fundamentally driven. To sum it up, I would argue that "averaging down" or "scaling" into positions has to be evaluated on a market specific basis and that markets with bigger mean reversion are the best candidates.

#14 HoseB

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Posted 29 July 2004 - 07:02 AM

Averaging down is playing with fire. You may get away with it many times, but one day it will clean your clock. I used to averag down "a little" on futures plays. Most of the time I was hoping to "save" a trade going against me, and sometimes I'd take a loss or 4-5X what I should have on a stop. That's a baaad strategy. Now, I adhere to a "one price level stop" parameter. It's much better and safer to stop out and re-enter when you see a new setup.
40,000 headmen couldn't make me change my mind....

#15 SideShowBob

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Posted 29 July 2004 - 07:21 AM

40 Bits of Trading Wisdom - Bit #25

Averaging down on a position is like a sinking ship deliberately taking on more water.

cap -- the point of the post was to question that wisdom -- not to say it was wrong but to make people think about it. OFten what's known as conventional wisdom is wrong.

As for the Martingale trading system, that relies on having 50/50 odds of winning. You could make the argument that after a 5% decline in the market the odds of a rebound are not 50/50, but higher (due to shorts wanting to lock in profits, whatever). This of course may change the odds.

In roulette each spin of the wheel is completely independent of the prior spin. However in the market today's price (and price change) is somewhat related to yesterday's price and price change so the odds may not be 50/50, and may in fact be in your favor (maybe someone could run the numbers -- or I'll try this weekend). Also since you need an RSI below 30 to even enter the first trade, and then we're assuming another 5% slide, you're talking very oversold and very likely to bounce (unless it crashes, which is very unlikely -- not impossible -- just unlikely).

In short I don't think this system is as dangerous as the Martingale trading system, but that doesn't mean it's not dangerous....

SSB

#16 securelstmile

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Posted 29 July 2004 - 07:59 AM

I have two accounts. One a long term long account that I do not trade. I average down all the time. This is money that I will not touch for 10 years. I think that is more cost dollar averaging. I try to buy the doom and gloom, though. Tell me you hate a sector. That is when I want in. Buying tech in there now My trading account I use stops. I don't average down but rather get out and then re evaluate my position when things stabilize.
The harder I work, the luckier I get.

#17 TechSkeptic

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Posted 29 July 2004 - 11:31 AM

Simple rule: Averaging down is only allowed if it's part of the trade plan, e.g. if you plan to start with a half-position to get a foot in, but expect a pullback and plan to buy the other half lower. That's okay. But never average down as a reaction to being wrong, that will wipe you out. And as for the Martingale system, the reason it doesn't work is because no one has an infinite supply of capital.

#18 TechSkeptic

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Posted 29 July 2004 - 11:42 AM

40 Bits of Trading Wisdom - Bit #25

Averaging down on a position is like a sinking ship deliberately taking on more water.

cap -- the point of the post was to question that wisdom -- not to say it was wrong but to make people think about it. OFten what's known as conventional wisdom is wrong.

As for the Martingale trading system, that relies on having 50/50 odds of winning. You could make the argument that after a 5% decline in the market the odds of a rebound are not 50/50, but higher (due to shorts wanting to lock in profits, whatever). This of course may change the odds.

In roulette each spin of the wheel is completely independent of the prior spin. However in the market today's price (and price change) is somewhat related to yesterday's price and price change so the odds may not be 50/50, and may in fact be in your favor (maybe someone could run the numbers -- or I'll try this weekend). Also since you need an RSI below 30 to even enter the first trade, and then we're assuming another 5% slide, you're talking very oversold and very likely to bounce (unless it crashes, which is very unlikely -- not impossible -- just unlikely).

In short I don't think this system is as dangerous as the Martingale trading system, but that doesn't mean it's not dangerous....

SSB

By the way, I do understand the point about the odds of a reversal increasing as you stretch further into oversold (or overbought conditions). From what I've seen people do, it looks like a better way to play that is to wait for the reversal to occur by setting a buy stop (to enter long) or sell stop (to enter short). This helps somewhat to avoid the falling knife. Then once entered, you still have to manage the trade with appropriate exit orders of course.

#19 TechSkeptic

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Posted 29 July 2004 - 12:14 PM

One more comment: regardless of the odds of success on any given bet, a system where you "double down" is inherently unstable, because the amount of money you have at risk increases exponentially with each loss. Even if the probability of wipe-out is low, if it happens: game over! Dollar cost averaging is somewhat better because the amount at risk increases only linearly, not exponentially, and I do in fact employ that in my 401k with periodic adjustments based on market conditions.

#20 SideShowBob

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Posted 29 July 2004 - 12:25 PM

TS, You made some great points. I really like the idea of waiting for a reversal before buying back in, that's a great idea. I'm going to see if I can modify the system and only buy after an x% reversal (say 1 or 2%). SSB