Averaging down a losing position in a mean reverting situation

[robster970]

Yesterday, I went off piste and did something 'dirty'. I averaged down on a trade. It was an intraday trade and the thought process went something like this. There is a screen shot to accompany what I did.

a) Yesterday opened in range on ES

b) Price struggled to make it past 59.75 area, the VPOC from Tuesday. T&S showed sellers coming in heavily here. Delta progressively -ve

c) Figure my trade opportunity is when 55.75 gets busted. This level has been held but I can see sellers overwhelming buyers generally on higher TF.

d) Go short at 56.25

e) Buyers show up, see some fight. It has immediately gone off side so I am anticipating bailing.

f) Gets to about 58 and I think to myself that today looks like it is mean reverting and am confident that gap will close (60.25) and turn

g) I hold until it gets to the gap close at 60.25 and wait a couple of minutes that it is running out of steam. I go short at 59.75. My average price moves up to 58. I have doubled my risk but am confident today is a mean reverting day due to the choppiness seen whilst the initial balance was forming.

h) It sells off again and I exit when it gets a bit sticky at 56.75

Was I just lucky there considering that it was fairly obvious that nobody wanted to trade above Tuesday's VPOC or would some consider averaging down in this kind of scenario a viable strategy? I am at pains to point out that the day was not an OTD or ORR or OD so felt comfortable that the 2-way auction creating the chop was setting up for a mean reverting kind of day.

The only point of hesitation I had was when it got to 58 and whether to half my risk back to normal. I chose not to.

Incidentally the 55.75 did get busted with a low at 53 with no extension past the gap close high of 60.25

 

[barjon]

rob

Well, I'll be Devil's Advocate.

When you arrived at this point - f) Gets to about 58 and I think to myself that today looks like it is mean reverting and am confident that gap will close (60.25) and turn - how come your confidence didn't lead you to cover the short and then prepare for a re-entry short on the gap close? I'm sure you'll have done the maths, after all.

jon

 

[robster970]

This is the crux of it Jon.

The answer was to do with the aggregate win. I could have taken 1.75pt loss and then a 3pt win netting me 1.25pts at 1 x risk. What I chose to do was double up risk and essentially take a 1.25pt win at 2 x risk. This is also why I didn't de-risk when price hit 58 on the return leg.

Now you could argue that because I was so confident, why not cover the short and then go in with twice the risk at 59.75?

The honest answer is that I didn't think I needed to take a loss because prevailing conditions would ensure a profit. It's not exactly rational.

 

[barjon]

rob

Aye, or you could have closed, new trade on gap close and made an addition where you covered the first short.

However, you chose the dangerous route since it HAD to go right to avoid accelerating losses. Given that this couldn't be guaranteed (despite your confidence) it's still the favourite play to be sure of only 2 small losses if the gap play failed.

 

[tar]

Was I just lucky there considering that it was fairly obvious that nobody wanted to trade above Tuesday's VPOC or would some consider averaging down in this kind of scenario a viable strategy? I am at pains to point out that the day was not an OTD or ORR or OD so felt comfortable that the 2-way auction creating the chop was setting up for a mean reverting kind of day.

There is nothing should stop you from averaging down i don't see a problem but before you do so you should know in advance how many times you are willing to add to your position , and at which point you're willing to giveup and exit at a loss , make a plan and stick to it ...

 

[robster970]

I agree with you Jon in a general sense that it is a ludicrous strategy to follow and one that is good for triggering risk of ruin if account size is small.

To be clear though, I am being very specific in it's use here, i.e. market conditions that are clearly a 2-way auction with a strong tendency to revert to the mean with little sign of big money participating and low volumes leading to what was a pretty choppy day with little directional conviction.

If session had have opened with an Open-Drive, Open-Test-Drive or Open-Rejection-Reverse scenario, one where directional conviction was obvious, there is absolutely no way I would have considered averaging in. It was only because prevailing conditions made me consider that there was a very high probability of a rejection of price at the gap close through sustained and heavy selling activity at 59.75, twice, within the first 30mins of open.

So as a general strategy I do heavily concur that it is pretty dim. In this particular situation, I am yet to see a compelling reason for not adopting it. Obviously the flip side is that when it does go wrong, I am probably sat on a loss about the size of 2 weeks trading.

 

[robster970]

General note - I scale in some times on my swing trades. I am not talking about this here. This is deliberate use of averaging down to recover a losing trade when there is a high probability that prevailing conditions favour averaging down.

 

[robster970]

There is nothing should stop you from averaging down i don't see a problem but before you do so you should know in advance how many times you are willing to add to your position , and at which point you're willing to giveup and exit at a loss , make a plan and stick to it ...

So plan for it and take it on the chin when it doesn't work basically.

 

[counter_violent]

Looks like some more columns for the spreadsheet. Keep a seperate record for the times you employ this strategy and in 6 months you may have the answer !

 

[new_trader]

My 2¢: Let’s say that you have figured that the market is just about to bottom out and is due for a substantial rise. You have two choices:

1) Wait until the action of the market confirms your opinion and in doing so sacrificing a few points profit as insurance.

2) Enter slightly early with a smaller position than your usual stake allowing you room for error and the ability to averaging in.

This is absolutely not the advice I would give to newbie’s but it looks like you have a bit of a clue. When it comes to trading the ES I am definitely in the 1st choice camp. Naturally this works the same for tops as it does for bottoms. The reason so many lose money in trading is they hate to see the market move away from them and want to 'jump on board'. I now gladly give up 5 points 'profit' if I am sure I can get 1 point out of a move.

 

[robster970]

Looks like some more columns for the spreadsheet. Keep a seperate record for the times you employ this strategy and in 6 months you may have the answer !

That's exactly what I was thinking whilst I was just in the shower..

 

[tar]

So plan for it and take it on the chin when it doesn't work basically.

NO , you should decide how much you are willing to risk from your account on your position/s it could be 2% or 20% , this will not change if you enter at once or you enter at 5 times , your predetermined risk per trade will not change ...

 

[wackypete2]

I agree with Tar, averaging down is fine as long as you had already planned for it before entering the 1st trade, otherwise you're just doubling your normal risk. IMO you were smart to exit the entire position instead of just 1/2. Remember it's not about being right, it's about being profitable at the end of the day or week.

Peter

 

[tar]

BTW as long as we are talking about the S&P , i asked TradersAudio ( Ben ) about it at an online webinar he said yes sometimes locals at the pit do average down but i don't want listeners to try it ...

 

[barjon]

I agree with you Jon in a general sense that it is a ludicrous strategy to follow and one that is good for triggering risk of ruin if account size is small.

To be clear though, I am being very specific in it's use here, i.e. market conditions that are clearly a 2-way auction with a strong tendency to revert to the mean with little sign of big money participating and low volumes leading to what was a pretty choppy day with little directional conviction.

If session had have opened with an Open-Drive, Open-Test-Drive or Open-Rejection-Reverse scenario, one where directional conviction was obvious, there is absolutely no way I would have considered averaging in. It was only because prevailing conditions made me consider that there was a very high probability of a rejection of price at the gap close through sustained and heavy selling activity at 59.75, twice, within the first 30mins of open.

So as a general strategy I do heavily concur that it is pretty dim. In this particular situation, I am yet to see a compelling reason for not adopting it. Obviously the flip side is that when it does go wrong, I am probably sat on a loss about the size of 2 weeks trading.

Rob

Apart from the fact that it's pretty much a no-contest from the theoretical maths point of view, it seems to me that you are talking about averaging down on a single trade when, in reality, you are talking about two completely separate trades with two completely different sets of rationale (as you describe it, the first is a downward breakout and the second a reversal).

If you'd only had the first to play with then I'm sure you wouldn't have hesitated to take your loss when it went "wrong". So where's the logic in hanging on to it because you see a very different sort of opportunity further away when you know that you will have to ratchet up your running losses before you come to it?

Maybe your "crime" is not about making an addition, but about moving your stop loss on your original trade

jon

 

[DionysusToast]

Well - big push down, lots of volume is often the end of a down move. You shorted at the exact point in which a reversal back up was very likely.

Personally, if I was to short that, I'd be looking to get short at a better price, so wait for it to move back up a bit. In the least you'd expect the market to be somewhat imbalanced at that low point because of the big move down and the amount of volume. In the least a pullback up would be very likely.

You lucked out I reckon - in respect of you doing this on a low range day.

Your second entry was a blinder.

You certainly have some

 

[Shakone]

This is the crux of it Jon.

The answer was to do with the aggregate win. I could have taken 1.75pt loss and then a 3pt win netting me 1.25pts at 1 x risk. What I chose to do was double up risk and essentially take a 1.25pt win at 2 x risk. This is also why I didn't de-risk when price hit 58 on the return leg.

Now you could argue that because I was so confident, why not cover the short and then go in with twice the risk at 59.75?

The honest answer is that I didn't think I needed to take a loss because prevailing conditions would ensure a profit. It's not exactly rational.

I think it's a dangerous game judging from your post. Nothing wrong with averaging down if that's part of your strategy.

You say you thought it was a mean reverting day. If so, shorting at 56.25 seems a very strange entry. On a mean reverting day, why enter right near the low when you fully expect it to come back to the mean and then the other side of the mean/range. So one can guess that at that point you didn't think it was a mean reverting day. Later on when in a losing position you thought it was a mean-reverting day and perhaps you were right on this occasion, but it seems from outside that you could be changing your view to accommodate the losing position. Sooner or later that's going to hurt.

 

[robster970]

Remember it's not about being right, it's about being profitable at the end of the day or week.

So this sits at the forefront of my mind, every time I sit down for the day with a soft target for the week and where I am in relation to it.

I feel the skill is being able to constantly grind results out rather than the doctrine of strict rule adherence. I prefer the term guidelines.

Yesterday I perceived there to be a high probability that taking the increased risk would pay off. Today I'm questioning the viability of it as a longer term mechanism which is contextually sensitive to mean reverting conditions and I'm interested in the variety of responses.

 

[new_trader]

I agree with Tar, averaging down is fine as long as you had already planned for it before entering the 1st trade, otherwise you're just doubling your normal risk. IMO you were smart to exit the entire position instead of just 1/2. Remember it's not about being right, it's about being profitable at the end of the day or week.

Peter

Actually, it is about being right, but at the right time. That is what makes you profitable at the end of the day or week.

 

[robster970]

You say you thought it was a mean reverting day. If so, shorting at 56.25 seems a very strange entry.

I assumed a range extension up until the buyers who had been loitering at 55.75 the day before turned up again. This led me to believe that sellers were active at 59.75/60.25 and the buyers were trying to hold up from 55.75.

Hence I then concluded this would now be Mean Reverting.

I know what you are trying to say Shake but I'll drop a view with a heartbeat on intraday. I also agree that trading like this will eventually conclude with like I said, 2 weeks of work down the toilet.