Many of us have used it. Danger of Forex averaging method?
General definition of averaging.
The averaging method in the market is a simple set of actions designed to compensate for losses by synthetically shifting the entry point relative to the chart.
Example:
Suppose a trader received a signal to buy a EURUSD currency pair at a price of 1.2500 ...
In this case, the trader opens the Buy position with a working lot (for example: 0.1). After this operation, the price moved down by 500 points and the price of the Euro fell to 1.2.
The averaging tactics implies that after a certain threshold of losses you need to open the same position as before, but at a better price, which in this example means adding purchases of 1.2 in the amount of 0.1 lot.
This simple maneuver shifts the entry point to 1.225, and from now on, the speculator does not need to wait until the price returns to 1.25 in order to reach the breakeven point. In this case, it is shifted 250 points lower, which certainly gives an advantage.
Benefits.
The advantages of this strategy are small and the basis of them is effective loss compensation. But subject to one little-known condition: you cannot add more than one averaging position, since the efficiency of a point shift without / loss decreases with each new position. The most important thing in this method is dividing this distance by 2. Then it will always be a larger number than 2 and excess volume can provoke additional problems instead of helping you.
"Additional problems."
As you can already guess, the drawback of this strategy is very serious:
- building an unprofitable position.
Trading is always beneficial when you choose the right amount of position in relation to risk. This means that before entering the market, the trader needs to pay attention to the potential and quality of the signal, and then choose a lot and risk based on the probability of making a profit.
But when working by averaging, a person first enters the market based on the above parameters, and his statistics give him a certain advantage. However, after confirming the fallacy of the entry, the person, instead of going out in the stop, adds a position. This is a very detrimental technique, as it obliges you not to use stops, and you also encourage incorrect positions.
And it seems like it's okay, but when working with this method, you endanger all capital or a significant part of it, which will be very difficult to restore.
Suppose:
- You risk 25% of the deposit in the transaction (for long-term or super-short-term trading, it’s quite a working risk);
- Having entered the transaction, you can also earn 25%;
- if the signal is incorrect, you must exit after receiving a 25% loss and re-enter the market, counting on your positive trading statistics;
- instead, the position is averaged and you become 2 times closer to profit, but in case of an additional market move against you, you will need to get a 50% loss, which also became 2 times closer due to an increase in the overall position;
- The saddest thing is that in order to recover this loss you need to make not just one successful transaction, as in the version without averaging, but as many as 4 profitable transactions (at this risk, double the deposit)!
Skew in favor of markets.
The main disadvantage of the averaging method is the violation of statistics against you, each profitable transaction gives you a fixed profit, and each unprofitable one brings a fourfold loss or more.
Ideally, you need to do the opposite, namely add a position to a profitable signal. By working in this way, you will cut the loss "in the bud", and make it possible for profit to grow and violate trade statistics in your favor, and not in favor of the market.
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