Averaging down experience

[sinner]

Firstly that's not really averaging down, that's a trading plan where the profits are made by paying the 'average' price of the index fund over a year by purchasing in a few lots, with the expectation that the market will continue it's increases.

But if you don't see it that way:

Personally I still see that as being "wrong". If you were right about your analysis than you would be holding your capital and buying into the index funds at times that will start generating you returns as soon as you invest, not tying up your capital in periods of downturns.

Err what? What if I've done a 100 year analysis against the Dow and decided that the start of the quarter is the best time of year to passively invest funds into the index?

Which is in fact why (for example in this trading plan) I waited all quarter to invest my capital?!

Still disagree with you here!

Averaging down, by the very nature of the technique, requires you to purchase additional shares at a price below what you originally paid - therefore you were wrong in your initial analysis and are attempting to compensate by lowering your cost basis and bring it closer to your second entry price (which you are hoping will be correct). The cycle repeats until either your stock hits a bottom and reverses, stagnates or delists.

If your analysis was right in the first place you'd be in the 'black' straight away rather than being in the 'red' and needing to bring your cost basis down.

Ok, not going to bother discussing with you on this one as you've made your mind up exactly what is going on here it seems.

Yes you are still wrong even in this example as you had to purchase on the way down. Put it this way: say you're looking at a fictional stock XYZ - by some divine measure you know for a fact it will go down in the short term. Would you buy this stock and average down? Of course not - you know it's going down so you'd wait and buy it at a cheaper price right? Why on earth would you buy in, knowing it'd go down tomorrow, and then attempt to average down? Nobody would do that of course - but that's what the average down strategy is.

Ok let's take a look at fictional stock XYZ. After declining for 6 months from $1.20 prior to which it had undertaken a 12 month rally, it has established minor support at 60c and major support at 59c.

Do you wait for 59c "of course", according to you. Me, I don't mind buying a little at 60c, as probabilities indicate to me minor support has a good chance of holding without testing major support.

Scenarios that can unplay from here:
1. I am in small at 60c, and you are not. XYZ rallies to $1.20 and the market rewards each of us commensurately for our risk taken.
2. I am in small at 60c, and you are not. The next day XYZ falls to 59c, and I go in with the remaining capital allocated for this trade. Again, the market rewards each of us commensurately for our risk taken.
3. I am in small at 60c, and by 59c we are both in. The next day XYZ closes at 58c and we both get out for a loss.

From my experience in real life, trading EURGBP on a correlation basket basis EURUSD/GBPUSD, EURJPY/GBPJPY, EURCHF/GBPCHF - I would prefer to be shorting or buying before the correlation re-asserts itself! In fact once the correlation has returned the rewards become much much lower. This means the market happily pays me for being, as you put it, "wrong".

I also notice, in similar example to above, in the "ASX Pairs Trading" thread, people are very happy and profitable to short the spread between two instruments after its exceeded 1.5 or 2 std dev of the 14 day mean, and add more if it reaches 2.5 std dev. To make it clear, this is just a plain simple bet that the distribution of the average of the spread is Gaussian or near-Gaussian, and the further it gets away from a normal distribution, the more you average down in your bet that it is a normal distribution!

 

[Boggo]

Hey Boggo, can you do an experiment for us/me? Can you apply your trading methodology to the MND chart from say Nov 2008 (where it was the lowest low) and tell us what trades you would have done? And P/L if you just apply a 2% rule?

The confirmed reversal of the downward trend really didn't happen until around 10th June 09, see chart below for explanation.

I have only had two trades (both winning) on MND as shown on charts below.
My intention was to go long again for a third on 21st April but it gapped past my order at $19.61, I have since pulled the order but may re-instate it at the same level if the low stays intact as the ABC is still valid with a software generated target area (see bottom chart).

Hopefully these charts explain my approach.

(click to expand)

 

[Boggo]

RIO, waiting for direction.

(click to expand)

 

[skc]

The confirmed reversal of the downward trend really didn't happen until around 10th June 09, see chart below for explanation.

I have only had two trades (both winning) on MND as shown on charts below.
My intention was to go long again for a third on 21st April but it gapped past my order at $19.61, I have since pulled the order but may re-instate it at the same level if the low stays intact as the ABC is still valid with a software generated target area (see bottom chart).

Hopefully these charts explain my approach.

(click to expand)

Thanks Boggo. I will start another thread with your data if you don't mind.

 

[Boggo]

Thanks Boggo. I will start another thread with your data if you don't mind.

Good idea, we may be able to shift some of this over there as we have derailed this thread a bit (except for RIO maybe).

 

[Frank D]

It really depends on where your first entry is, where the Index is at the time, and
where your 2nd entry is.

For example, buying a stock at its 3-months highs and then averaging down is
stupid.

Buying a stock near the 3-month 50% level and then averaging down is not as bad,
but still carries at lot of risk.

in both those instances you should be using stops.

If you are going to use an average down type of strategy (not with
leverage, but with CASH) then the 'less risk' strategy would be using the
3-month lows of the stock as the first entry.

The 2nd entry would be in the following quarter, and once again use the
dynamic 3-month lows…

There will be far greater chance that price will converge
towards the 50% level after the 2nd entry in the following Quarter.

Whether that convergence gets you into the black, is another matter.

I wouldn’t use this type of strategy with specs, but with blue chips I have no
problem employing cash positions in falling markets.

 

[KurwaJegoMac]

Err what? What if I've done a 100 year analysis against the Dow and decided that the start of the quarter is the best time of year to passively invest funds into the index?

Which is in fact why (for example in this trading plan) I waited all quarter to invest my capital?!

Still disagree with you here!

If you do your 100 year analysis and determine that the start of every quarter is best and therefore invest at the start of that quarter - and after investing in the start of that quarter the index falls further - you're analysis was wrong. Your stock is worth less than you paid for it so once again, simply put, you are wrong. If you were right in your analysis, your stock would have risen in value.

Ok, not going to bother discussing with you on this one as you've made your mind up exactly what is going on here it seems.

the point of a debate such as this is to present your own personal view on the matter and argue for or against it. Being unable to offer a suitable rhetoric opposing my argument is no reason for such off-hand remarks.

Ok let's take a look at fictional stock XYZ. After declining for 6 months from $1.20 prior to which it had undertaken a 12 month rally, it has established minor support at 60c and major support at 59c.

Do you wait for 59c "of course", according to you. Me, I don't mind buying a little at 60c, as probabilities indicate to me minor support has a good chance of holding without testing major support.

Scenarios that can unplay from here:
1. I am in small at 60c, and you are not. XYZ rallies to $1.20 and the market rewards each of us commensurately for our risk taken.
2. I am in small at 60c, and you are not. The next day XYZ falls to 59c, and I go in with the remaining capital allocated for this trade. Again, the market rewards each of us commensurately for our risk taken.
3. I am in small at 60c, and by 59c we are both in. The next day XYZ closes at 58c and we both get out for a loss.

From my experience in real life, trading EURGBP on a correlation basket basis EURUSD/GBPUSD, EURJPY/GBPJPY, EURCHF/GBPCHF - I would prefer to be shorting or buying before the correlation re-asserts itself! In fact once the correlation has returned the rewards become much much lower. This means the market happily pays me for being, as you put it, "wrong".

I also notice, in similar example to above, in the "ASX Pairs Trading" thread, people are very happy and profitable to short the spread between two instruments after its exceeded 1.5 or 2 std dev of the 14 day mean, and add more if it reaches 2.5 std dev. To make it clear, this is just a plain simple bet that the distribution of the average of the spread is Gaussian or near-Gaussian, and the further it gets away from a normal distribution, the more you average down in your bet that it is a normal distribution!

Unless the price is moving in your favour you were wrong. No one would buy a stock unless they believed it to be moving in their favour. If you wish to enter on standard deviations or spreads or distributions thats fine - but if the stock goes lower after your purchase you were wrong in the timing of the purchase.

Your position size and risk is determined at your entry price - if you need to buy in again at a lower price you are increasing your risk as you increase your position size. You were therefore wrong in your first position. Anyone can hold a stock for 'x' amount of time and claim that they were finally proven right - thats the joy of a positively biased instrument such as the sharemarket. It doesnt mean you were right when you made the entry

 

[nulla nulla]

Okay I admit it, I am an Average Downer.

Decrying the practise of averaging down is, in my opinion, an unjustified generalisation. Traders/Investors are supposed to research their shares and know as much as possible about them before making a decision to trade/invest with that share.

I also admit that, despite my best efforts, I have difficulty in picking the exact top of a share price rise when I should sell and the exact bottom of a share price fall where I should re-enter.

I have researched and follow several shares in different indexes. I monitor the trading channels established by past share price movements. If the channel is moving upward I am prepared to enter at a slightly higher price than the previous bottom. If the channel is moving down, I am prepared to enter at the previous bottom and top up if the opportunity arises. If the channel is moving sideways I enter near the previous bottom and again lower if the opportunity arises.

When I enter I normally already have an exit price selected and I often place the share parcel(s) in the queue(s) immeadiately after the purchase. Sometimes I get the determined exit price wrong and the share fails to hit my price, in which case I can either wait (confident it will with some additional time) or I can lower the price taking less profit. Sometimes the price moves past my designated exit and I miss out on the peak. Not a problem, my profit is locked in. Sometimes I let the profit run until I feel it is time to lock in the profit, regardless of whether or not the share price may go higher.

Averaging down can be dangerous. It is not for beginners and should only be done when you have done your own research and are familiar with what factors drive the movement of your chosen share.

 

[KurwaJegoMac]

Okay I admit it, I am an Average Downer.

Decrying the practise of averaging down is, in my opinion, an unjustified generalisation. Traders/Investors are supposed to research their shares and know as much as possible about them before making a decision to trade/invest with that share.

I also admit that, despite my best efforts, I have difficulty in picking the exact top of a share price rise when I should sell and the exact bottom of a share price fall where I should re-enter.

I have researched and follow several shares in different indexes. I monitor the trading channels established by past share price movements. If the channel is moving upward I am prepared to enter at a slightly higher price than the previous bottom. If the channel is moving down, I am prepared to enter at the previous bottom and top up if the opportunity arises. If the channel is moving sideways I enter near the previous bottom and again lower if the opportunity arises.

When I enter I normally already have an exit price selected and I often place the share parcel(s) in the queue(s) immeadiately after the purchase. Sometimes I get the determined exit price wrong and the share fails to hit my price, in which case I can either wait (confident it will with some additional time) or I can lower the price taking less profit. Sometimes the price moves past my designated exit and I miss out on the peak. Not a problem, my profit is locked in. Sometimes I let the profit run until I feel it is time to lock in the profit, regardless of whether or not the share price may go higher.

Averaging down can be dangerous. It is not for beginners and should only be done when you have done your own research and are familiar with what factors drive the movement of your chosen share.

Yeah that's fair enough, I see where you're coming from. I think your last paragraph is key - if you're a fundamentalist then averaging down can be part of a viable strategy (as you're keen to accumulate at a target buy price and will continue to accumulate as long as your buy price isn't breached).

 

[mazzatelli]

From my experience in real life, trading EURGBP on a correlation basket basis EURUSD/GBPUSD, EURJPY/GBPJPY, EURCHF/GBPCHF - I would prefer to be shorting or buying before the correlation re-asserts itself! In fact once the correlation has returned the rewards become much much lower. This means the market happily pays me for being, as you put it, "wrong".

I also notice, in similar example to above, in the "ASX Pairs Trading" thread, people are very happy and profitable to short the spread between two instruments after its exceeded 1.5 or 2 std dev of the 14 day mean, and add more if it reaches 2.5 std dev. To make it clear, this is just a plain simple bet that the distribution of the average of the spread is Gaussian or near-Gaussian, and the further it gets away from a normal distribution, the more you average down in your bet that it is a normal distribution!

It's valid with a relative-value model [correlation, co-integration arb] with defined boundaries.

It's a different mindset to lowering a cost basis for a directional bet gone astray, which I think is what the rest is harping on about.

 

[tothemax6]

I don't follow the whole 'average down' stuff.
You are supposed to buy when you see upside, and sell when you see downside. Nothing else.
Sure, you may buy a stock, and its price goes down. Whether you choose to sell that stock or buy more should depend on what information you have about the stock, your conclusions upon completion of processing that information, and how certain you are (how 'risky' the trade is). Same applies to bonds, currency, and commodities. Your current holdings and the price at which you bought them should not affect your current sales or purchases (there may be of course, practical exceptions such as a margin call if you are using credit).

I know some people here buy purely on the price action, i.e. 'which way the crowd is running'. So if the price goes down, 'dump the stock'. However, it must be noted that if the entire crowd is trying to guess the direction the crowd will next go in - the whole thing is random.
This is not the case - the market agents do process information outside the set of market agents. They factor in news into their purchases, they factor in macroeconomics, they factor in uncertainty etc. If they did not, one could be just as assured of making a good purchase today even if WW3 breaks out tomorrow, or if the company has a terrible debt load, or if the company is trying to sell spinning wheels.
The people who are selling down the stock are not always right. Sometimes those who buy from the sellers are right.

 

[Reasons]

The upshot of this discussion seems to come down to your frame of reference and whether you have actually tried strategies that utilise averaging up or down, or not. It is easy to see who has as they don't defend too hard as they know it flies in the face of textbook logic, but in reality does have a place as some have indicated.

During the GFC, there were massive arbitrage opportunities in the indicies in CFD's. Because there were huge 3-5% swings happening daily at times during the really intense period of the GFC, at least one CFD provider was placing their open for the day after the US market closed at over 80 points higher or lower to the previous day's close (sometimes well over 100 points).

The trick to trading this was that the index was set too high by the provider and sometimes for a short amount of time after the market opened, the index would nearly always pull back down or go back up a significant number of points to meet the real market index level, and then continue to follow the market movement correctly for the rest of the day.

I was collaborating with two other traders at the time over Skype and we would work out the likely odds on the arbitrage together prior to the close early in the morning after the US closed and get set if we thought the arbitrage worth trading.

At the 9:50am open the CFD provider would often run the index even higher or lower depending on the market direction. You had 3 choices at that point. 1. Sit on you original position and sweat out the likely swing back; 2. Panic and get out (probably why the market maker was running the index up or down even further) or 3. Average harder and fast into the swing against you.

The most successful one of the 3 made ~$78K over about 3 months using this tactic and it was because they were the most aggressive with averaging into the swing against them to maximise the points being offered in the arbitrage trade. Anyone who was trading indicies during this period will know what it means to eventually have over 200 contracts placed on the XJO or FTSE and hold your nerve during the wild swings that occured on the opening of the market.

Unfortunately the market started to calm down and this arbitrage trade just stopped working. My point is that you would probably find many more instances where averaging up or down works than has been offered in this thread. You will probably also find that there are others that are in use today, but the traders are just not going to flag it here. An interesting discussion; but as it flies in the face of the text books your position towards the strategy will just come down to your practical and importantly successful experience with its application.

 

[So_Cynical]

I took a mid sized average down into PTM today...at about a 7% discount to my original parcel of shares brought almost 12 months ago, reasons for taking this trade are (in no particular order).

• SP clearly below post GFC support.
• Need to increase my position size to reflect my current position size policy (plan)
• I love the business...brought in today for the same reasons i brought in almost 12 months ago
• I had the money

PTM thread linked below.

https://www.aussiestockforums.com/forums/showthread.php?t=6463&p=631172&viewfull=1#post631172
~

 

[skc]

The most successful one of the 3 made ~$78K over about 3 months using this tactic and it was because they were the most aggressive with averaging into the swing against them to maximise the points being offered in the arbitrage trade. Anyone who was trading indicies during this period will know what it means to eventually have over 200 contracts placed on the XJO or FTSE and hold your nerve during the wild swings that occured on the opening of the market.

Unfortunately the market started to calm down and this arbitrage trade just stopped working. My point is that you would probably find many more instances where averaging up or down works than has been offered in this thread. You will probably also find that there are others that are in use today, but the traders are just not going to flag it here. An interesting discussion; but as it flies in the face of the text books your position towards the strategy will just come down to your practical and importantly successful experience with its application.

Lol I thought I was the only person doing that. It was definitely nerve wrecking to hold such massive positions (my maximum was $250 per pip), even though I was supposed to be fully hedged. I was using one smallist provider and if they go under I would have had a naked $1m position that could swing 5-8% against me over night... I also had to keep my capital in 3 equal parts - 1 part to each provider (that I am arb against) and the 3rd part in the bank to satisfy any margin calls. Luckily only needed to use that once, but having a -$50K loss in one account overnight is not uncommon.

Probably wouldn't do that again... although I did enjoy making money by simply clicking buy/sell at the same time (I used 2 CFD providers, 2 computers, 2 mouses and 2 hands ).

BTW averaging down in this instance is not really a meaningful comparison to averaging down with long positions. With long trades you are not arbitraging anything...

 

[skyQuake]

The upshot of this discussion seems to come down to your frame of reference and whether you have actually tried strategies that utilise averaging up or down, or not. It is easy to see who has as they don't defend too hard as they know it flies in the face of textbook logic, but in reality does have a place as some have indicated.

During the GFC, there were massive arbitrage opportunities in the indicies in CFD's. Because there were huge 3-5% swings happening daily at times during the really intense period of the GFC, at least one CFD provider was placing their open for the day after the US market closed at over 80 points higher or lower to the previous day's close (sometimes well over 100 points).

The trick to trading this was that the index was set too high by the provider and sometimes for a short amount of time after the market opened, the index would nearly always pull back down or go back up a significant number of points to meet the real market index level, and then continue to follow the market movement correctly for the rest of the day.

I was collaborating with two other traders at the time over Skype and we would work out the likely odds on the arbitrage together prior to the close early in the morning after the US closed and get set if we thought the arbitrage worth trading.

At the 9:50am open the CFD provider would often run the index even higher or lower depending on the market direction. You had 3 choices at that point. 1. Sit on you original position and sweat out the likely swing back; 2. Panic and get out (probably why the market maker was running the index up or down even further) or 3. Average harder and fast into the swing against you.

The most successful one of the 3 made ~$78K over about 3 months using this tactic and it was because they were the most aggressive with averaging into the swing against them to maximise the points being offered in the arbitrage trade. Anyone who was trading indicies during this period will know what it means to eventually have over 200 contracts placed on the XJO or FTSE and hold your nerve during the wild swings that occured on the opening of the market.

Unfortunately the market started to calm down and this arbitrage trade just stopped working. My point is that you would probably find many more instances where averaging up or down works than has been offered in this thread. You will probably also find that there are others that are in use today, but the traders are just not going to flag it here. An interesting discussion; but as it flies in the face of the text books your position towards the strategy will just come down to your practical and importantly successful experience with its application.

That was actually just wild swings on the SPI - the CFD indices base their values on the actual futures (which open at 9:50)

I remember for a period there were huge gaps in the futs open where fund managers liquidated before the cash mkt opened. Those gaps got filled a lot of the time. Fun trading, would have probably had better fills with CFDs though!

 

[skyQuake]

I took a mid sized average down into PTM today...at about a 7% discount to my original parcel of shares brought almost 12 months ago, reasons for taking this trade are (in no particular order).

• SP clearly below post GFC support.
• Need to increase my position size to reflect my current position size policy (plan)
• I love the business...brought in today for the same reasons i brought in almost 12 months ago
• I had the money

PTM thread linked below.

https://www.aussiestockforums.com/forums/showthread.php?t=6463&p=631172&viewfull=1#post631172
~

Do you consider technical at all when u average?

eg. the chart looks horrible, its tested support so many times and each bounce is weaker and weaker; its almost popped thru.

 

[So_Cynical]

Do you consider technical at all when u average?

eg. the chart looks horrible, its tested support so many times and each bounce is weaker and weaker; its almost popped thru.

MMM i see what you mean, the top trend line is clearly down..lines up nice too, funny how often those trend lines run straight in line...however all that interests me in that chart is the support and the fact that PTM fell clearly thru it today...for me that's a clear buy signal and that's what i imminently did.

I've learnt over the last 2 years that about half of the times i see what i did with PTM today and hesitate...the buying opp is gone and im kicking myself for being to cautious, sure half the time it goes against me but they have always come good before (over time) and will continue to do so im sure...happy to collect the dividends and wait it out.

 

[tothemax6]

Probably wouldn't do that again... although I did enjoy making money by simply clicking buy/sell at the same time (I used 2 CFD providers, 2 computers, 2 mouses and 2 hands ).

Ha, niiiiice. That my friend, is enterprising.

 

[Reasons]

Lol I thought I was the only person doing that...Probably wouldn't do that again... although I did enjoy making money by simply clicking buy/sell at the same time (I used 2 CFD providers, 2 computers, 2 mouses and 2 hands )

Damn, we thought we were the only ones . Yep, they were fairly heady times in the market, but I would do it again and better.

BTW averaging down in this instance is not really a meaningful comparison to averaging down with long positions. With long trades you are not arbitraging anything...

It was actually using this strategy with indicies that got me thinking about using similar tactics on longs with banks that I indicated elsewhere in this thread, not that long afterwards when the world was going to end as we knew it in late 2008. As you say, not an arbitrage trade in this instance, but what I considered a high conviction (if I did not talk to anyone else about it) averaging down long bet that I believed was weighted significantly in my favor. The logic and tactic paid off and I have used the experience gained to get myself out of trouble more than once since as I can now analyse possible solutions to tactical trading conundrums through a wider frame of practical references.

 

[brty]

There is a distinct problem with "averaging down" that has not been discussed, and that is asset allocation. If your plan is to average down then you must start with a much smaller position. Otherwise you would be over allocated in that stock.

The frustrating part comes when 2 or 3 stocks go up in price, therefore no average down. Your winners have a much lower proportion of your funds in them compared to your losers.

If the plan is to average down or average up, then you will have less commissions by just buying a full commitment in the first instance.

The greatest problem with averaging down is that it works most of the time, until it doesn't. If a trader uses the methodology (and hence throws prudent asset allocation out the window) and it works well for them, eventually a stock comes along with good fundamentals that keeps going down without stopping. The average down trader with success in the strategy will keep going at the stock. I know of a trader who did this ~15 years ago, eventually 60% of his portfolio was tied up in the one stock that went bust. He had doubled his stake (in $) the day before it was suspended from trading, it was his eighth "average down", and the one that was going to reduce his loss by just going up for 2 or 3 days.

So_Cynical,

I have observed that we often have the same buying point on quite a few stocks, due to buying support, however this is not what I would deem to be 'good support' which is what I look for. Good support is support that is reached for the first time after a series of higher highs and higher lows. What you have here is what I call 'poor support' as the previous low was not on the way to a higher high, but a lower high. What I have found is that 'by separating 'support' into 'good support' and 'poor support', the probabilities of trades working are greatly enhanced.
I would have $3.50- $3.80 as the 'good support' level for PTM.

brty