Far and away the worst error anyone can commit is to add to a position that is a loser.
There is no worse curse than making money while violating this most cardinal of trading rules. We are only setting ourselves up for the one that doesnít come back.
Averaging, as it is called, means that we are going against the trend of the market. Our initial decision was wrong, and now it is compounded by our hoping that the market wonít have to come back much in order to show a profit.
For example, we initially purchased XYZ Options at 20 and now it is selling at 16, and we decide to buy more. We would be guilty of adding to a losing position. The converse is true for the short side. We are hoping that the trend of the market will reverse soon in order to prove our initial decision right. Often it does. When it doesnít, major hemorrhaging occurs.
Doubling up is predicated on the hope that the market will reverse itself. It flies in the face of the trend at that moment. Who says that a market has to reverse itself?
For a real chuckle, go through Barron’s and see how many pundits thought the stock market could not go any higher. They cited all sorts of statistics based on past markets.
Start in 2020 when we had the COVID Crash . Each and every month another market guru came along, arguing that the market couldn’t go any higher. If you had listened to them and played the short side, you would have gone very, very broke.
Doubling up has ruined a lot of people. In order to double up, you must go against the flow. You are saying, I WIll know that the market is going to turn and prove me right. No one knows when or how! The market is like the little ball in a roulette wheel. It goes round and round, and no one knows where it will stop. We can go along for the ride, though.
We double up because our egos do not like being wrong. They tell us to hold on, gut it out, double up, do anything but admit that we are wrong. Our ego will invent the weirdest rationalizations for adding to the losing position. It will go through strange mathematical constructions showing that because our average cost is lower, we can get out profitably with just a slight reversal in the trend. But who can tell when that reversal will come?
Our egos trick us into doubling up a losing position. They refuse to look directly at reality. They want to be right no matter what the cost. A lot of people would rather be right than make money. Their egos are making all the decisions
When a trade is not working out, traders sometime have a tendency to keep putting more money into the trade in order to get their average prices down. But they don’t realize that they are only digging a deeper hole by throwing good money after bad.
If your trade is giving losses, just accept that it was not a good trade, take a modest loss and get out. Do not keep messing around with it by adding more capital to it or one day market will cut you very deep.
Doubling up works more times than it doesnít. Unfortunately, we never know when it will not. When we double up, we eventually go belly up!