Averaging Down with Support & Resistance

Although the "Black Swan" outlier event can happen, averaging down on the whole numbers while using support & resistance levels have proven to be extremely profitable - especially in Ranging Markets!

I'm familar with Paul Tudor Jones' "Losers Average Losers" assertion. However, I'm familar with quite a few wealthy traders that uses the averaging down strategy during specific market conditions. An additional leveraged boost to averaging down is to increase the lot size as you average down. For example, if the 1st position is 1 lot, then the 2nd position would be 2 lots, the 3rd position would be 3 lots, etc.

Of course, the the "deeper one's pockets" the better chance you'll have to succeed... but on the flip side, the potential for a LARGE LOSS is greater as well.

Based on my MM criteria, the only way I would lose is if a currency price moved in a given direction for more than 2000 pips beyond a support or resistance level without at least 700 pips of retracements during this run. The 700 pips of retracement can be dispersed throughout the 2000 pip run, as it would not be necessary to have a 700 pips retracement all at once. For example, a retracement of 100, then a couple of days later, another retracement of 200 pips then a few days later, another retracement of 100 pips, etc. Also, if the distance between S&R is 500 pips, then that's a 2500 pip run without the retracements. I'm sorry, but the market has yet to do that... However, I understand that there's a first time for everything.

I know this is a HIGHLY UNCONVENTIONAL approach; however, the backtesting clearly shows the profits are there without blowing up, even throughout the high volatility periods in the last 2 years.

Your thoughts...

Walt

Btw... utilizing averaging down with fib pullbacks from S&R levels have also backtested quite well...

Hi Walt

This sounds like a combination of dollar cost averaging, martingale, and a form of grid trading...wow, talk about unconventional, you don't do things in half measures do you!

Isn't the risk:reward skewed out the wazoo? Would the payoff over and above more conventional and safer investments be worth the risk bearing in mind how much money you need to have in reserve? Also don't forget there is very little that is yield positive at the moment, the carry costs could mount up if you're stuck in positions for a while, plus what do you do while you're waiting for a trade to play out, it's 'dead' money being tied up like that.

I'm not trying to put you off the idea but you did ask for thoughts

Hi Pipmutt,

Actually, the risk:reward is favorable if you stay in a retracement to or beyond the initial entry price. That's why using this for temporary pullbacks can be very profitable.

Good points about "carry cost" and "dead" money... however, I just consider it a "cost of doing business". Having the patience to wait for the correction in your favor is a fundamental key for this to work.

Personally, I would recommend enough MM capital to endure up to 25 or 30 positions against you.

Please understand that if that "100 year" event catches you, then the Big Blow-up will occur. Nonetheless, in life we sometimes have to "go for it" when the odds are in our favor...

Walt

Hello,
May I ask what your backtesting consisted of? How many years did you go back? The current global financial and political landscape is susceptible to so many possible "Black Swans" that I would personally be wary of any investment schemes that rely on normalcy in order to bank profits. The possibilities for further huge financial dislocations that could potentially lead to unprecedented currency moves are legion in our relatively near future. Being caught averaging down on the wrong side of such a scenario could be disastrous. The Market Wizards series of books is filled with admonitions from some of the greatest traders ever against the practice of averaging down in any situation. Yet there is not one trader in that elite group that recommends the practice. I personally would not bet against that group. I am positive you could find similiar or greater rates of return trading much more risk-averse methodologies that would actually benefit from the Black Swan outliers instead of having to hope and pray they don't occur.

A

Thanks for your input... I've looked at the July 2007 thru Dec 2007 for the gbpjpy and Dec 2008 thru Jan 2009 for the gpbusd. I sought out the most volatile & trending periods to test.

I agree in principle, this is a potentially dangerous strategy, although it has a low probability for failure. Nonetheless, failure is certainly possible.


BTW, what other "risk-averse methodologies" did you have in mind?

thanks,

Walt

Averaging down, when used properly, is a valid strategy, Mate. For example, if you only put on part of your position to test the waters, it is OK to add to it SO LONG AS you do not blow your stop loss or your position size. Stick to your per trade risk no matter what.

Adding to losers to trade your way out is a myth. Get off the wrong train immediately and wait for the right train to leave the station.

"BTW, what other "risk-averse methodologies" did you have in mind?"
***********
Volatility Breakout strategies are just one of them. They come in various shapes and sizes, but if traded with discipline ( a very big "if"..) and good money management it's hard to find one that does'nt test positive. Also the nature of volatility breakouts is such that they actually thrive when the occassional Black Swan rears its ugly head. I much prefer to trade a system that does just fine in "normal" market conditions but can do better when the outliers occur, than one that can potentially go tilt if a surprise occurs. And again, I believe the current state of the globes financial systems is ripe for surprises.

Jones 247,

Your approach will definitely work for someone who is not affected by drawdown and obviously has deep pockets or plans well for the drawdown.

Yes it works. I started basically selling (writing) currency options some 15 years ago and there was a period I had to hold the sold baby for 1.5 years and more.

I can say it happened with 20 times at least. Mostly cross currency pairs linked with Kiwi, Kangaroo currency and Candy.

At no point of time I thought of taking loss and all the positions ultimately reversed. I just had to watch my statement showing big drawdown up to 45% while my income from writing the option was hardly 1%. I had no pressure for margin call so I let it run for months together.

Only after getting into spot forex after my retirement and watching charts I could see New Zealand dollar (a sham currency and milk prices supposed to be its major fundamental) and commodities currencies are the market maker's trump cards and there is not enough liquidity in these currencies.

The market makers could simply wipe out a lot of margins by sending big spikes without any reason in these currencies during the time of carry trade.

Now carry trade is dead (interest rates offered in each country are almost same) but market makers won't let these "cash cows" go. If you think deeply these countries don't have significant fundamentals to command so much premium in their currencies. In fact, New Zealand government wants their currency to be abolished and instead use Aud so that their small economy can be managed properly.

Now I am quite comfortable with spot forex and have given up options trading. Conventional Asian traders emphasis on hedging in same instrument and I realised what a boon that was. The major problem is to change your mindset and train your mind not to get affected by hedged positions.

Many a times you get caught in stop hunts (bear/bull traps) even if your setup is well planned. In such a situation, without thinking too much I enter opposite transaction after 20 pips drawdown and lock the loss.

Once I hedged a position it used to bother me a lot and I stopped looking at other opportunities. Impatience was also affecting my judgement. I was making mistakes in timing pullbacks/reversals. My psychology was not allowing me to function properly.

A trader then told me that I should change my defensive approach. After all I had enough margin for another 20-30 trades and I was merely locking up my 1% margin on each trade. And that too with 20 pips drawdown locked. It was not a big deal.

His advice changed my trading pattern. Instead of thinking about the locked positions I mentally visualised that I will keep them aside for today and plan strategy for it next day and not to stop my day trading.

Next day it happened to be a data day. So I waited for the news to finish and once the market had jumped it started retracing. I liquidated one of my hedged positions and surprisingly it got me 100 pips profit in a matter of 5 minutes.

I thought it was a coincidence but it gave me a strong motivation to focus on timing of reversals. Since then my study of identifying reversal points has become deeper and it is paying off me every day.

Now I have made it a habit to take my locked positions and throw one of the positions at news trading (or momentum) waves and take what the market gives in a short time. I must say I am enjoying it.

The best part is that because of hedged positions I am forced to look at all kind of reversal setups. I identify reversal points and try to time them . But at times when I don't succeed I hedge further. From 20 pips to 40 pips and then I don't attempt to trade that locked position on that day. I leave it for next day. Times are there where I have failed five times resulting in 100 pips total drawdown. But at the end of the day none of the hedged positions gave me any loss. It has resulted in Breakeven when I thought trading zone had shifted or good profit if the reversal happened with momentum driving it.

After going through this hedging phase I realised there was nothing to fear.
Greed was there earlier but when I realised I needed to spend a lot of hours watching charts (and if it was really worthwhile to do so) I became disciplined and now I take what market offers me with gratitude during 6 GMT to 9.30 GMT.

I am attaching a picture to show if someone has capacity to digest drawdown without affecting health then you really don't have to worry. Please do me a favour . Go through this chart and estimate drawdown and how many retracements happened and suggest me a money management strategy based on the six months of drawdown so that I could write a system for use for retired persons who are willing to accept drawdown as part of the harzards.

PJ

I'm sorry PJ, but I don't see how hedging helps. If you have two opposite positions, when you close out the winning side, the losing side may easily continue. unless a solid retracement occurs, you're simply dying a death of a thousand cuts...

Walt

I use averaging in my trading, but all my trades are of the same size, and much more important you cannot average using a fixed "every x pips", because the market is dynamic and so your averaging must be.

So.. yeah averaging is the most (the only?) way of make constant profit from the market for me, and i know that a big number of profitable traders trade like this too.

Keep averaging up!

the few wealthy trades I know all trade like this, but do so via pyramid scale-in's with a predetermined max risk at an estimated bend level. in order to pyramid good bends at key s/r's, you need good capital. that's the catch.

These two sets of statements contradict themselves, Yes?