Averaging Down
It’s common to hear that as a trader, you should never average down. After all, throwing good money after bad isn’t the best way to come out ahead in the long run. Investors with longer timeframes are happy to see lower prices to allow them to improve their cost basis, but a trader who makes a habit of adding to losing positions will at some point pay dearly.
But….
There is a time when it’s OK to average down – when you originally planned to do so. Maybe you’ve been stalking XYZ stock to short sell a quick rally right to resistance. It is looking like a double top to you, so you decide to put on a partial position to see if you’re right. The stock begins to roll over, bounces a bit past your entry but resistance holds, and you put on more shares. This is the kind of scenario in which adding to a losing trade is acceptable with your stop-loss nearby. You planned to do so, and adding to the trade only took you to a full position size – not above it.
On the other hand, we’re all plenty familiar with the blown stop loss and that urge to improve our average price by adding to a losing position. Those are the times when emotion is taking its toll, and the need to be right overcomes goal number 1 of capital preservation. You’re soon over-exposed in a stock that you’re clearly wrong about. Adding shares in times like that are a recipe for pain and an eventual disaster. Getting away with it a few times just reinforces a bad trading decision, and it’s gonna hurt down the road when it fails to work!
So if it’s part of your original plan to add to a trade at worse levels, then go ahead and do it if you still have the conviction. If you’re stuck in a bad trade and you’ve already got more than you want, look for a good spot to exit and rid yourself of the trade ASAP.
Jeff White
President, The Stock Bandit, Inc.
www.TheStockBandit.com
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