Healthcare Enterprise Group

Crikey! Looks like another reads my posts too. lol

"Thursday, December 21, 2006
Average up, not down

When you make a second trade after an initial trade in the same market, you can view your cumulative exposure as a single position at the average of the two opening prices. The general idea of averaging in this way is to make a greater profit by increasing the amount traded in a single market.

Averaging down is the name given to the practice of placing a second trade after an initial trade is in place, but the price of that initial trade has moved in the opposite direction to your original plan. For example, a trader might initially purchase at £1 per share believing the price is going to rise. However, the price actually falls and moves down to 90p per share. The trader then places a further trade for a similar number of shares, thus averaging down his trading price to 95p per share.

In my opinion, averaging down is not good practice. If your initial trade is showing you a loss, this is telling you that something is wrong with your original hypothesis. You should be thinking about cutting the loss before it gets much larger instead of throwing good money after bad.

Averaging up (or pyramiding) on the other hand, is a much better practice. This is when you place a second trade after your initial trade is already in profit. The market is telling you that your initial hypothesis was correct and the the price is trending in the direction you anticipated. Therefore when you place a second trade you will be trading in the direction of the trend and leveraging your exposure in a much more effective manner."