Otherwise known as the Lenny Dykstra School of Trading. He learned it from Cramer. ‘Nuff said.
Raise your hand if you’ve ever done this.
Good, I see that everybody has at least one hand up, including me. Been there, done that, got the scars to prove it.
One of the best rules of trading is “never add to a losing position”. The best thing to do when you find yourself in a hole is quit digging.
However, (there’s always a “however” in trading) .. there is a right way to go about averaging down. The right way starts with a plan. The plan starts with a maximum allowed loss amount.
Let’s say that you want to buy XYZ at 20, with a maximum loss of $200. You could
Buy 200 shr with a stop at 19 ($200 risk)
or
Buy 100 shr with a stop at 18 ($200 risk again)
Assume you take 100 at 20, stop at 18. Stock goes against you to 19. You still like XYZ. You could take another 100 at 19.
But your stop now has to be raised to 18.50 to maintain your original $200 max risk amount.
100 at 20 + 100 at 19 = 19.50 average cost
$200 risk / 200 shr = $1 stop loss = (19.50 - 1.00) = 18.50
However, (there’s always a “however” in trading) .. there is a right way to go about averaging down. The right way starts with a plan. The plan starts with a maximum allowed loss amount.
Let’s say that you want to buy XYZ at 20, with a maximum loss of $200. You could
Buy 200 shr with a stop at 19 ($200 risk)
or
Buy 100 shr with a stop at 18 ($200 risk again)
Assume you take 100 at 20, stop at 18. Stock goes against you to 19. You still like XYZ. You could take another 100 at 19.
But your stop now has to be raised to 18.50 to maintain your original $200 max risk amount.
100 at 20 + 100 at 19 = 19.50 average cost
$200 risk / 200 shr = $1 stop loss = (19.50 - 1.00) = 18.50
That is the only disciplined way to average down. You have to have an “uncle” point and you must respect it. You really don’t want to be a Lenny do you ?