We have read a lot on Averaging the losses and its consequences, either a loss or profit, else a zero sum game to make our broker happy. I am not addressing an individual sample and you might have experienced that the conclusions on averaging the losses are always unsolved puzzles, we need to stress more and analyze its effects in long run and just not on the trade examples which have favored us, if any !
Money is the basic raw material in trading, other way it’s just a medium of exchange for a consent value.
Let me discuss a case here. Assume, you like surprises and you test your fortune often with a lottery ticket that costs you 10$, reward will be a million dollars.
You got lucky and you won a million dollars. Thinking practically, what counts is only the ticket price and the reward by that certainly your 10$ is worth a million dollars now.
In other probable case you don’t get lucky and the value of 10$ is zero since you get nothing in return.
What I conclude is, value of Money fluctuates and is vulnerable to the asset class it is linked with, simple.
Averaging your losses in trades.
My understanding on this subject has been very clear after series of experiments on various parameters like stop loss, target and winning/losing probability. I believe that Averaging losses in trades done over a long period is pure recipe for blowing your trading account. Explanation follows
If you take a trade on xyz stock which is trading at 100$ and your stop loss which might be around 97-98$ with respect to 2% Stop loss theory to minimize the
hidden risk, if that stock now hits your stop loss and starts southward journey to 95$, what would you do? You can’t do anything if the stop loss is mechanical and not psychological-wait and watch. In the latter case, you may feel that stock may bounce from 95$ to your target zone or cost. Well, Fair enough, unless you jump in again and order for more quantities which is getting devalued, at the moment. You may think of adding ‘n’ quantities or more to catch that falling value, this is nothing but an illusion, it demonstrates our bias and does injustice to money management principles.
Money that you are having, has pre-defined value and you are degrading it by buying value eroding asset or something that is not sporting equal value to your ‘money’.
It’s a layman strategy and anybody respecting money management will sense averaging losses, as just another foolish episode. Very simple reason to dislike or keep away from averaging losses is that it puts our stop loss theory into shame, and we compromise our capital there on.
Let’s look at some facts and figures
Here is a column chart, consisting of data tested over million traders worldwide, hence the sample size can be enough to discuss (i Assume) .
We can observe that Forex trading is executed fairly by most of the traders out there, accounting to more than 50% in all the currency, they are winners and losers are lesser to winners.
Therefore, it is not about ‘positive trading capacity” of the traders but it is about money management that is putting people on the losing side.
Below is another data collection which emphasizes the above line
Averaging the losses is just a bad habit and also results in amplifying your odds or losses. I found no better reason to average : losing money and living peaceful 😉