Adding To Losing Positions or Averaging Down

[setravis]

PSYCHOLOGY ON TRADING.......

ADDING TO LOSING POSITIONS OR AVERAGING DOWN...

Pyramiding is a complex strategy, even for professionals but many times newbies use this method for a wrong purpose and wrong intentions.

I can't remember how many times I made a wrong decision to enter the market and it turned against my position. So instead of getting out and take a loss, I added more shares into the position. So losses mounted as the market kept moving against it. Here's the reasons why  newbies do it:

1) Making the loss per share not looking that big -- by adding the positions, the average loss per share is smaller than the first position alone. But we forget that the total loss is the main problem. The account balance looks at total loss, not loss per share. We are fooling ourselves by disguising one bad situation with a BIGGER one.

2) Try to avoid taking a loss -- By adding, it'll take a small amount in our direction for the position to break even. We believe that the market will bounce back quickly and we'll get out as soon as our position is 0 loss. And if the market just keeps going against the position?

3) Wasn't part of the trading plan -- averaging down is a way to cover up the trading plan that went bad.

4) So sure the market will go our way -- A belief that the market will correct itself and go in favor of our position despite all the contrary indications. Stubbornness and need to be right don't belong to trading. Drop all these hats when you step into the trading room because market won't let you be who you are, only what it wants you to be a trader who follow its rules and price action.

Here are the reason we can correct this fault:

1) Create a trading plan-- knowing when to get out and when to get before the trade. Keep position sizes small. Emotions will run amuck when a big position is taken. Take one position at a time and be comfortable with it.

2) Accept losses-- it's part of trading, have to get used to it. Being right 100% is impossible, no human is perfect so don't expect anyone to be, including ourselves to be. The market will remind us of that everyday.

3) Learn to listen to the market-- if the position is in a loss, it's time to listen up and understand what the market is telling us and be prepared to exit. Rationalizing is a neurotics game, not a trader's game.

Here's a question in this analogy: if we drive at an a excessive speed around the corner on a big cliff, the tires are starting to skid, and the car is starting to lose control, what do we do?

A) Slow down
B) Speed up

When we speed up, in trading, we're adding positions. The situation is bad but compounding it will not solve the problem. Slowing down may prevent the car to make the bend or stop near the edge but it's better than going straight off the cliff, unless that's what we subconsciously intended to doing.

[Ares]

Hi Setravis,

Would this strategy be considered averaging down?

Here's a scenario for example purposes.

Stock that has good volume and range with these indicators:

RSI2 below 30
Slow stoch below 20
MACD Divergence
at least on a 3rd down day

with these information from the previous trading day:

2.618  = 6.618
1.618  = 5.618

high    = 5.00
open   =4.00
close   = 4.50
low     = 4.00

1.618 = 3.38
2.618 = 2.38

Buy #1: 1,000 shares near 3.38 (at around the 1.618 level).

Stock goes down

Buy #2: 1,000 shares near 2.38 ( at around the 2.618 level).

Let's say, stock bounced to 2.88

Sell #2: 1,000 shares near 2.88 (still keeping buy #1)

Stock goes down again near 2.38 (in consolidation mode - maybe during the dead zone).

Buy and sell few times within the range.

Eventually sell buy# 1 at a loss or even better - at a gain.