Averaging down. To do it or not to do it...

I hope everyone is having a great weekend and Father's day.

I wanted to touch on the subject of averaging down when holding a position for a couple of reasons. A friend of mine, who I consider to be an experienced trader, did this recently. And, I have touched on this subject in previous posts, but feel it deserves a topic all by itself.

Averaging down - a double edged sword. You open a stock/position, the price goes against you, and you are left with a decision: Do you stop out, or increase your position size to reduce your breakeven point and get out/make profit sooner? We have all been there and done it at one time or another in trading.

And we have all heard the arguments before (for and against): Buy more! It's a great stock and it WILL come back - the market is in an upswing. Sell it! You NEVER average down.

I am not sure there is a definite, correct answer to this question. I think it's a 'It depends' anwser. Before you say that I am hedging here, let me explain and then give my own personal opinion.

I think it depends mostly on the type of trader/investor you are, and your portfolio. If you have deep pockets and can afford to not only average down, but expand your risk AND wait for the price to come back, then that's fine. If your position is a very small part of your portfolio, and averaging down does not put the position against your risk tolerance, then maybe.

But here are the real questions one should ask before averaging down:

• Why are you averaging down?
• Does averaging down expose the position to more risk than your plan allows?
• Is averaging down PART of your trading plan?
• Do you have an EXIT strategy should the position NOT come back? (i.e hard stop, etc.). I mean, you are not going to keep averaging down are you? (Note: if you answered yes, please close this page and erase all instances of my link from your browser).
• Most importantly, if you did NOT have a postion in this stock already, would you OPEN a postion now? Does this stock fall in the criteria of your plan if you wanted to open a new position? If you answered no, then I ask: Why are you buying (averaging down)?

I believe averaging down should only be done by experience traders who not only know what they are doing, but whose accounts are able to withstand the hit if it does not work out. And maybe, if you are investor with a very long timeframe and are willing to wait out the position.

In my opinion, traders should NOT average down. The minute you do, your focus now changes to 'Hope' that the position will come back so you can exit sooner. Hope is word that should be eliminated from a trader's vocabulary. There is a reason a position has moved away from you (usually, a pretty good one). If you like the stock that much, then wait for it to come back to your original sell point and THEN buy it. Or, even better, wait for another entry that falls within your plan. Take emotions and stress out of it (easier said than done, right?).

We've all been there before: you open a position, it moves away, stops you out, and then comes back. But this is the life of a trader. You live to fight another day. Think about all the times you got sopped out of a potentially disastrous situation.

I don't know about you, but capital preservation is much more important to me than making money. Why? Because I have a system that is reliable and will ALWAYS give me good entries to postions that make money AND fall within my trading style/plan. Losses are part of trading and unavoidable. It is much better to analyze WHY you got stopped out, and learn from a losing trade.

Above all else, and I cannot stress this strong enough, make sure you have a trading plan and are taking trades according to that plan. The minute you deviate, you'll get nailed.

Good luck with your trading.