Sooner or later we all end up with a losing position on a good quality share, we may feel that we can ride out the slump and wait for the market to regain its former glory. One technique we can use to assist is to average down our purchase price. With this strategy we would purchase another parcel of shares at a lower value effectively lowering the average purchase price of the entire holding.
Lets say we own a parcel of 1000 shares has been purchased shares for $10.00, and the position is worth less than the original purchase – Say $6.00 per share. Lets assume that no risk management has been applied (because if it was, you wouldn’t be in this position). Buying another 1000 shares at $6.00 would lower the complete average on the asset to $8.00.
So lets look at the right time and the wrong time to do this. The wrong time is when the market is falling, if you are averaging down into a falling market is very difficult to achieve a good result, because we don’t know how far the price will fall. If the price falls to $3.00 your decision to average down hasnt been a good one. The ramifications of getting this wrong may impact on your positions profitability, it may create an imbalance in your portfolio or in the worst cases give you greater exposure to a dying asset.
A more appropriate time to use this strategy would be to wait for the market to form a support base and bounce – at least in this way the market is moving in your favour again. Try to look at it like entering the position again — does it meet my normal entry criteria, if so its the right time – if not then wait until it does, or forget this strategy.
Ideally averaging down with the market bouncing off a support line and forming a bullish pattern is the time to average down, the stronger the move upwards the more likely you will have a successful trade.
In Short: Don’t Average Down into a falling market, go when the market is rising. Getting this right will give you the ability to lower your original entry price so you may trade out of the position with a profit.
Markets will often move in repeating patterns or ranges, there are a number of different names for this but breaking away from the titles, our obligation as traders or investors is to make good choices in our investments.
As observers watching a market our best opportunities come when we identify repeatable conditions. Sometimes we see that the price action is moving between an upper range and a lower range, sometimes called a channel. As a trader this offers some nice trading options, the biggest being a repeatable opportunity trading into the active “leg”.
A couple of things to consider when analysing a channeling trade;
- Trade with the dominant channel direction – One of the most viable principles in trading is to follow the more dominant direction. This is because the dominant direction will be more profitable. Of course it is possible to trade against this direction, though more care should be taken as it would be considered a higher risk trade. When channels are flat in direction profitable trades may exist in both directions.
- Connect your peaks or troughs – This is to gain an understanding of when the market is reaching the extremities of the trading ranges. Normally the channel is identified by connecting either a couple of troughs or peaks. Duplicate the first line and move it to the other side, often this can be done before the 4th leg has started. (see top image). Once the second peak is in place further adjust the angles of your lines.
- Larger channels take longer to reach the extremities, but provide you with a bigger return, smaller channels are faster and more frequent.
- Plot a mid point – The mid point of the channel will often cause the price to pause, stutter, stall or even reverse. This is more important on larger channels, but as valid on smaller ones.
In very simplistic terms – Buy at the bottom, Sell at the top and stay out of the middle. Now that’s about as generic as I can be, your trading rules should be a little more thorough.
From a reality perspective we will never trade the complete width of the channel, you will loose a little on each side. So determining whether or not a channel trade is viable is an easy choice – how far is it (in $) from the channel lines? This is the potential profit on the trade. When you shave from both sides, is there enough room for you to get in and out and make a buck?
Channels can be some of the best opportunities we have as traders, so do 2 things. Firstly, watch your channel regularly, identify the movements and speed – be ready for the next move. And second, tell me about it 🙂
Governments around the world did a fairly good job injecting funds into schemes to “kick start” their economies from the lows of early 2009. Eighteen months later we have seen a 50% retracement from the “Bear Market” through 08, with markets gaining ground nicely.
The steam started to come out of the market late 2009, transitioning from a nice bullish pattern into a sideways channeling movement. During this phase we started to see the hangover of the short 09 bullish surge.
Once the AXJO dropped below support at the 4500ish level in May 2010, the market shifted into a downward trend once more.
One of the biggest sayings in trading is “Trade with the trend – The trend is your friend”, the way we identify longer term trend changes is using the peaks and trough positions on the chart.
With that information, we must identify we are again with the Bears. So what do we do with longer term portfolios?
Three choices exist;
- Let it run, over the longer term the market will fight its way back to previous levels – provided the shares within your portfolio are sound.
- Exit your positions – bank your profits or cut your losses.
- Take an opposing positions to offset losses. This is called hedging.
Whatever you choose, make sure you take into consideration all the “pros and cons”.
The trend is your friend? Only if you recognise it and act accordingly.