| Trading Losses- How Averaging Down Can Make You Lose |
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| Written by Reece Mathews |
| Friday, 21 May 2010 15:40 |
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Money management is intended to protect you against severe trading losses. With rules to follow you don't have to worry about losing all of your trading capital. The sad news is that there are traders who use strategies that can disrupt the logic behind money management. Highly dangerous trading strategies include averaging down.
Money management is intended to protect you against severe trading losses. With rules to follow you don't have to worry about losing all of your trading capital. The sad news is that there are traders who use strategies that can disrupt the logic behind money management. Highly dangerous trading strategies include averaging down. Averaging down doesn't involve a lot of technical moves. What it entails is just buying more of a stock that is already well on its way down. This is clearly an illogical step to take. Why would you buy more of a falling stock? Traders who do so just don't see how illogical they have become. This is because they have become too focused on lowering the average cost per unit. When they look superficially at their trading profits and losses, they only see that they were able to buy cheaper units on average. These traders have lost a great part of their analytical skills. At this point, common sense should kick in. The strategy may push average cost down but this doesn't mean you will start to see profits. On the contrary, continuing to buy units of a stock that just keeps on falling can only serve to magnify your losing streak. There is a deeper explanation as to why traders stick to this strategy when it is obviously flawed. Those who continue to stubbornly apply it are in denial and are very desperate to recoup their stock losses. They can't see the error of their ways because emotions have taken over. They are too far distressed that no amount of logical prodding can snap them back to their senses. This is what makes addressing trading psychology important. Before traders even start trading, they should set the right mindset. The best psychological state to adopt is one that does not leave space for emotions to play. Decisions should be supported by facts and research. Moreover, they should be guided by a strong trading system that has been back tested. A plan can have several different parts but in general, your system is supposed to help you cut your trading losses to bearable bits. The part that best tackles the impulse to average down is money management. What this involves for the most part is setting risk levels that you can live with. There is thus no possibility that you will encounter future losses that are too much for you to handle. For you to be able to build a suitable money management plan, you have to set figures for your trading float, maximum loss, trade size and stops. There are different ways to establish money management rules. You may however want to consider averaging up. This is the opposing route to averaging down. Naturally, going up also means you have to pay higher prices. You should not mind the cost though because taking already proven profitable positions can only set you up for more potential gains. Initially, it may be difficult to take the step to cut your stock losses. It may be tempting to act on your feelings. When the temptation comes though, you should turn towards your risk management policies to keep you grounded on logic. DISCLAIMER: This article is provided as information only and is not to be taken as financial advice. Learn More About Trading Risk Management. Visit http://www.trading-secrets-revealed.com. |