Potential Problems in Manage Losing Trades

Potential Problems in Manage Losing Trades

Whether you are looking for investment opportunities in a growth, value, contrarian, or day trading context, losing is a reality of the financial markets.  Even the best of the market’s traders have bad days, and all we can really hope for is a rough 60/40 split between trades that enter in the black and those that enter in the red.  Since this is an inevitability, we need to be prepared for these negative scenarios and have some strategies for how to managed losing trades. 

 Averaging Down

“What many trader try to do in these cases (once they are in panic mode) is ‘average down,’’ said Haris Constantinou, currency analyst at TeleTrade.  “This essentially means that the trader is adding money to the position once the market has started moving in the opposite direction”.  But while this strategy does have the added advantage of improving your average price (since you are buying lower in long positions, selling higher in short positions), there are still some important problems that should be addressed.  The fact remains, in any case where averaging down is even possible there is an implied scenario that the market’s momentum is now actively working against you.  Any time you average down, you are in essence adding to a losing trade.  These practices can be particularly destructive for your trading account in cases where you are inaccurately assessing the market’s underlying momentum.

So, how do we define the wrong reasons for averaging down?  The first indication that a trader is averaging down for the wrong reasons becomes clear when the original rationale for the trade becomes invalid.  For example, if you are implementing a range trading strategy, and you choose to buy a currency pair into a key support level, the original rationale for the trade is broken if that support level is invalidated.  At this stage, there is no rational reason to still be in the trade and if you are averaging down at this stage, you are doing it for irrational reasons.  In these cases, traders are simply “hoping” that prices will reverse back toward their desired target, and this is an approach that should never be used in forex trading.      

The main problems in these cases will come in two forms:  First, you will only increase your losses and, second, you will be wasting valuable time and resources that could have been used to find a more constructive trade. This can be viewed as a “double loss” because you will not be able to remedy the inaccurate decision that you made in your initial trade.  There will also be cases where your ability to obtain a better average price will actually help the probabilities for your trade — and create gains that might not have been seen otherwise.  The key to knowing the difference comes after assessing price momentum.