The concept of averaging is well-liked by the less seasoned traders, though it is not a surefire. It may help tone down entry points and reduce the pressure of market timing but when not used right, it may even increase losses. Kar Yong Ang, financial market analyst at Octa broker, gives a brief description of what averaging includes, types of averaging, positives and negatives, and application of averaging in a more decent manner.
The averaging consists of changing your position size as the prices change, usually in the aim to take advantage of the trends. This method covers many markets, including Forex and stocks, crypto and commodities.
Most newcomers first experience averaging down in which one adds to their long position as prices decline thereby reducing the average cost of the position. One strategy that is not talked about as much but equally is legitimate is averaging up-buying into a short position as prices rise. Both of them are based on the principle of cost adjusting. An example is the buy of an asset at 100 and then again at 90 giving an average price as 95 and hence requiring less rebound to break even.
The pyramiding or price-based averaging is a method whereby you set the trade up as relevant, scaling it when the trade goes your way. In comparison to averaging down, it does not sell into an uptrend. The approach is becoming the trademark of trend traders who add positions in small corrections of a larger trend. It is also a highlight of a lot of algorithmic moves.
When you are purchasing a fixed amount of investment on a periodic basis then regardless of the changing prices of an asset one can use time averaging or Dollar Cost Averaging as it is more commonly called. It is a typical strategy in long-term plans-particularly in speculative domain plans such as crypto-and is meant to reduce the emotional strain of perfect timing and reduce the impact of getting hammered.
1. Maximizes the levels of average entry
Averaging into a position with attractive prices, be it in rising prices, or in falling prices, has the effect of decreasing average cost per unit. This is followed by comparatively less market shift required to achieve break up or profit.
2. Is able to increase returns in reversals
In case the market goes the other way, scaling to a bigger position at lower (or higher) prices may pay big dividends. Increasing its profitability can be brought by averaging down its long positions in anticipation of a bounce, and averaging up its short positions in anticipation of a correction.
3. Brings in order and clarity of entries
Rather than doing everything at once, averaging, and more so with a predetermined system such as DCA, makes the entry in trade somethings very handy and deliberate. This will eliminate the stress of identifying the right time.
4. Takes advantage of unsteady markets
In trading of assets that trade in ranges, this method can give more favorable entry prices better than a one-time mass acquisition. Traders can buy in pieces when the market is down so that they can accrue positions at good prices.
5. Reduces market timing regret Minimizes regret about market timing
The major concern of many traders is that the prices are going to drop just after one has entered a trade. This fear is strangled by averaging all as any decrease in price creates a fresh chance to join at improved value.
Although alluring, averaging is precarious and dangerous in the case of not following a disciplined manner. Randomly extending the amount of a loss trade-blindly- in particular, the idea of having no bounds; is commonly linked to the infamous martingale system. Such a practice of doubling up during drawdowns has led to innumerable trading fiascos of high profile traders. This technique can even turn into the dumbest guesswork since there is no stop-losses or strategies to get out of a position. Losses may also ramp up quickly without any apparent controls especially when leverage is deployed and margin levels contract fast.
The application of averaging requires an adequate approach of parting it into an efficient and rigorous trading scheme. Before opening a position put your trading triggers in place, define your maximum exposure and establish your exits. Do not make additions out of emotion: do not mix frustration or overconfidence with logic.
This method is most effective in organized situations in either the trending periods that the retracements provide fresh entry triggers or the determinant ranges which are those where the supports and the resistances are identified. Avoid when it is high news such as releases of earnings or some important economic news.
Minimize risk. If possible, never overexpose any position to above some low fraction of your total capital, e.g. 2% or less. Margin should always be good. In Octa platform, it is possible to apply such features as partial closures, time-based execution tools, and it does not require such precision and control over this strategy.
Average-down is not a way to deal with bad entries or timing of trades. It is an advanced device which demands wise implementation, emotional discipline and proper planning. It is the sort of thing that can turn a raging market into a matter of strategic advantage, when used carefully. But it can destroy your account in very little time when used wrongly.
Use averaging as part of a big picture-focused strategy on risk management, as opposed to wishful thinking. Hope is not one of the things that guides the most successful traders because they base their judgments on rules, structure, and discipline.
Disclosure: This text is not investment advice, is not financial advice, and considers neither your institutional objectives, financial situation, nor tolerance to risk. Only you are responsible in making trading decisions on this information. We and Octa are not responsible when it comes to the consequences of your activities.
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