Averaging Down: Martingale


One of the common errors made by losing traders is to “double up to catch up” where they try to recoup their losses quickly by taking irrational and rushed positions. If their last trade was a losing trade then instinctive reaction is to panic and increase your trading size or take greater risks.

The manner of increasing the size of your position as you are losing can be described as a “martingale strategy”. The best example of this is betting red or black at the casino. Let’s say you start off betting £5 on red and you lose. Your next bet would be to double your amount to £10 and if you lose again then your next bet would be to double it again to £20. If you eventually win you will get your money back plus £5. Sounds like a good strategy right? Well not so. Casinos are well and truly onto this and so enforce table limits or maximum bet sizes so you cannot continue to double your bet in order to eventually win. They also have zero and double zero on the roulette wheel which means the odds are stacked once again in the casino’s favour, plus at some stage you’ll likely run out of money with a big enough losing streak.

Another common reaction is to decrease your trading size or to stop trading all together because you have lost money and confidence.

Anti martingale strategies have, however, been proven and tested for decades to be the most effective way for professional traders to maximise their opportunities. Anti martingale is where you decrease the size of your position when you lose and increase the size of your position when you win. This works very powerfully to ensure you remain in the game for as long as possible but it does require discipline and tenacity in order to stick to it and not get greedy.

Whether you like it or not, in this industry you will experience a losing trade but you can’t live by your last trade. Treat every trade individually in line with your strategy.

The above contribution by Capital Spreads: Feature: Capital Thinking #4 – Learn from your mistakes. If a lesson was expensive don’t pay for it again.
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The average up/down argument is not always easy to reconcile in one’s mind, I accept. Averaging down is all about buying into a stock that you are already invested in and which falls down in price – you buy in more at the lower price to lower your average price.Spread betting money

The average up/down argument is not always easy to reconcile in one’s mind, I accept. Averaging down is all about buying into a stock that you are already invested in and which falls down in price – you buy in more at the lower price to lower your average price.

I tend not average down as, for me, it is merely reinforcing that either ones timing was wrong (in that the market is not yet ready to take the stock higher) or, fundamentally one has made a mistake in the stock selection … in either case to get in deeper on a dropping price would seem to be compounding ones problems and also tying up a larger proportion of one’s available cash resources that might now take a whole lot longer to recoup let alone make a gain on. If a stock does not do as i expect, early doors, then I usually exit and seek another entry or another stock unless my strategy is intentionally to build a large position in a thinly traded stock some considerable time ahead of when I think it will come back into favour (I have two in which I am currently doing this in, using small trading gains, with a view on mid-2012 as the time when i anticipate the return of favour for said stocks).

A much more experienced trader once told me that stocks are like solar bodies…take a position in a satellite and tend it as it grows to a planet…but always have a few other satellites on watch with a view to finding the next planet in the making. These things take time and can’t be hurried by sheer force of will.

I prefer to take a position and then, after a period of time in which the stock has performed to expectations, consider making a top-up during a period when the price is softening (due to nothing more discernible than consolidation or lack of immediate news flow) but said top-up should be some way ahead of one’s average to date and the size of the top-up be smaller than any any prior investment…this way one is buying more of a winner (validating ones now proven belief in the stock) but always keeping one’s average well below the dominant trading range that the stock is now in….i.e. providing a ‘margin of safety’ – if things go wrong, one therefore has a better chance of exiting and preserving ones capital to fight another day with.

“I think the other aspect to this is if you’re not sure why a stock price price is falling, then it may be prudent to hold off, particularly if the price is falling against, or relative to, the wider market. In that situation I would prefer to wait for news, so that I can check that the company is on track. You might miss part of the recovery but it is a strategy less likely to lose you money. Better to top up shares that are rising and risk gaining more when you are already in profit although psychologically it is harder to do!”

Eventually in the life of a stock I believe there comes a time when it matures to a point where one can have sufficient confidence to finally, perhaps dramatically, build into it for the real big gain….such instances are uncommon but need to be taken when they come along as it only takes one or two such events to transform the overall performance.

I simply don’t average down unless in exceptional circumstances or as part of well thought out and timed process where i can say that averaging down is only part of my initial stake building on a very long term play and based purely on having to simply wait for the market to give me the stock I want due to poor liquidity. As a general rule i would far rather pay more for a stock than I would pay less for it.

In any case I have no doubt there are differing successful strategies according to different times and trends in the prevailing marketplace. Proficiency can only really be measured over a long period of time and through a variety of market scenarios… at some stage in the future the ‘short’ side will become more successful and that will be a new challenge and therefore a new set of emotions to manage and strategies to refine.

I’ve watched countless Martingale Muppets wipe themselves out in half an hour at blackjack tables. Painful to watch. You don’t need to be a genius. Just sit under the dealer (so you have as much information as possible) and keep a rough count of 10s, As and mids. Up the stakes when the 10s get shy. You can stand on 12, the house can’t. Never insure.

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