Defensive Money Management Explained: Second Component Of Averaging Down

By Lawrence

DefensiveMoneyManagementExplained_2ndComponentOfAveragingDownAverage down on losers madly is one thing. Controlled average down is something else totally. In this article I am going to discuss the second component of strategic average down.

Before we start it is important that you do not skip the basic concepts of money management and just read this part in the series out of context. You will learn the technique but it will not serve you well unless you know why you should not employ the strategy casually. Read Defensive Money Management Explained from the beginning will give you a solid foundation in understanding the more advanced topics presented later in the series.

Average Down The Wrong Way

Many people noticed that if they got caught in a very bad situation they can double down or even triple down on the losing position so that the average cost of the position is closer to the current price level of the market. When the market snap back from the directional move, they stand to bail out of the position, either at a small loss or win. That’s all good as long as the market stopped moving in the same direction after the triple down. If it does not stop, the traders who average their losers will lose so much money they face the risk of being wiped out by the market.

It is important to know how to average down correctly which means you know:

1. What you are getting yourself into

2. What is necessary to make it work

3. When to give up when it fails

 

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Comments
  • MidKnight May 21, 2014 at 1:16 am

    Good writeup LC, thank you.

    I’ve studied dozens of entry/exit from the top performers on sites like zulutrade and myfxbook. The huge majority of them are doing some sort of average down approach – many of them at static intervals and mostly within the day timeframe. You’ll see some of them posting spectacular gains, but most of them do die in the end. Some however, do not – or they have a way to game the ranking system through a withdrawl/deposit scheme that I haven’t figured out yet.

    Really good writeup.

    With kind regards,
    MK

    • Lawrence Chan May 21, 2014 at 4:18 pm

      According to myFXBook, they forbid systems using martingale from offering subscription.

      But many of them, are definitely using averaged down hence the blowups.

  • melvyn May 21, 2014 at 8:15 am

    Are there any specific criteria in employing this strategy? How does this average down concept compared to reverse your wrong way and double up the dominant direction hence forth. I find that averaging works only if you roughly knows a ceiling or bottom is near and do it from there with the understanding of capital and/or leveraging ability.

    • Lawrence Chan May 21, 2014 at 4:21 pm

      1. Read the article again, in details.

      2. That is Martingale.

      3. You are confusing the use of “scaling” into a position which has fixed entry zone and clear stop loss once the zone is breached.

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