Adding to a loser – is it a lifeline or a millstone around trader’s neck?
What is adding to a loser and how does it differ from averaging? Why most traders think that it is a sure way to bankruptcy? When is it good to increase your losing trade size and when is it bad? Can you employ adding to a loser as a winning strategy? What is Martingale trading and how to use it in Forex? You will find the most detailed answers to these and many other questions in my article.
Adding to a losing trade and averaging down. What is the difference?
Adding to a trade size is the way to boost you opened trading position in order to increase the total size of a particular trade. Differently put, when you add to the trade you open one or more orders of the same type as the initial position, to increase its volume.
Averaging is a way to hedge an opened trading position in order to correct (move) the entry point. In other words, averaging is used by traders who are trying to finds an ideal entry point.
So, it follows from the definitions that adding to a trade size is used to boost the position and averaging - to adjust the trade entry. Very often, these concepts are either confused or simply misunderstood, so they are believed to be the same thing.
Both adding to a losing trade and averaging were originally used with a single purpose, to reduce the risk and to save a position from a loss. However, often these methods, wrongly applied, lead to that an added position is not a way to avoid losses, but, on the contrary, a way to suffer from more losses.
Let’s study both methods in more detail and find out why they are treated so negatively, although they are quite useful ways of trade management.
Averaging in Forex
As you have already known, averaging is used to extend the trade entry and is done like this:
The above figure presents the EURNZD price chart in the H4 timeframe.
Supposing that the pair will continue falling down, we decide to enter a sell of 1 lot at 1.74800 (Sell 1.74800 (1 lot)).
However, instead of falling down the price starts moving in a sideways trend. Expecting a possible outcome as one of the scenarios, we assume that the entry point was chosen not entirely correctly, there might be a short-term up movement up to the resistance to the local downtrend (light green dotted line). After that, the price should reverse and start moving down. In this case, we face a choice of two scenarios. We can leave the position unchanged and wait through the price growth, followed by a decline. Or we can employ the averaging method and move the entry up along with the price movement. In some situations, it is better to act according to the first scenario and stick to the original position; but, in the given example, we are willing to change the position.
So, the averaging way implies opening one more orders of the first trade type. In the given example, the order should be put higher in the price chart; this implies that at the time the additional order is opened, the first one will be yielding a loss. We put a pending order for the averaging position at the level, where we think the price should touch the resistance (Sell 1.76200 (1 lot)). If the price grows further and the pending order works out, we will have a total sell position, consisting of two orders of 1 lot each with different opening prices. The difference between the prices will be 1400 pips, so the actual entry point will move higher and will be at 1.75500 (New enter 1.75500 (2 lot)).
However this averaging transaction won’t be complete. Our entry point will be moved, but there will two important deviations from the original strategy:
- The entry point is moved but hasn’t been fixed, so it will be moving according to the price movements, which can result in unplanned outcomes.
- The total trade volume will be 2 lots instead of the original size of 1 lot. This may subsequently lead to an increased load on the deposit and increase the amount of collateral for the transaction.
To return out trade to the original size, but with a new entry point, we need to eliminate the deviations. To fix the new entry point, we need to close the averaging order when the price reaches the level of the new entry. So, the averaging order will generate profit that will be equal to the loss, yielded by the first opened order. Therefore, the arithmetical result on the account balance will be 0. This way, we shall fix the new entry and eliminate an additional load of 1 lot.
Well, we studied a perfect way of averaging. However, the price may not go according to our scenario and our averaging trade will work the other way round and yield a loss, rather than a profit. This time, averaging becomes adding to the position size.
Forex trading with adding to a loser
So you employed the averaging method, but the price hasn’t stopped growing close to the supposed resistance level and, having broken it through, continued rising.
Therefore, the situation by now is so that the current price is 1.77100. We opened two orders with opening prices of 1.74800 and 1.76200. Both these orders are yielding losses, and the loss from the first trade is more than that of the second one. What shall we do next?
Next, we again need to make a choice, but out of three scenarios now:
- To leave everything as it is and wait for the price to reverse and go in the needed direction eventually.
- To close both orders with a loss and exit the entire trade, in order to avoid more possible losses.
- To add more lots to our shaken trade, thus adding to a loser
I should note in the beginning that if everything did not go according to your initial plan, and the current price growth came as a complete surprise to you, so the averaging was for you only an attempt to take any measures to correct your own mistake, you should safely choose the second scenario and close your orders.
You should choose the third scenario with adding to a loser only if you understand and realize how it can affect your deposit, you have the knowledge and the skill to add to a loser, and you fully measure your deposit amount against a possible drawdown after the adding to a loser position.
Well, we ignored all warnings and cautions, and consciously decided to add to our losing positions.
First, we must figure out a potential price movement against our initial position. This way, we’ll know a reference level where the price can go to. You can identify the level of the possible further movement by means of any analysis methods you know. The most important is that you are honest with yourself. What am I talking about? I mean that is if you determine the level with too low expectations only because you want the nightmare to end and the price to reverse as soon as possible, adding is likely to destroy your deposit and you’ll join the huge army of adding-to-a-loser haters. I personally, calculate these levels, according to the basics of technical analysis, trend theory. I base on highs and lows of previous trends.
Well, let’s suppose that we have identified the level of possible reversal. Now, the hard work begins. We need to figure out in pips the distance between the expected pivot point and the nearest order, we opened. We need it to understand how many pips we can get deeper in the drawdown. In our case, the estimated pivot point is at 1.79400. I will not tell you how I identified it; I’ll just say that it was quite clear in the D1 timeframe. Well, 1.79400 - 1.76200 = 3200 pips. The value is rather big and suggests the following: such a distance won’t be covered by the price in 1 day; the experience proves that it should take at least a couple of weeks. So, we see now that the entire transaction may take at least a month. If aren’t prepared to wait and worry for such a long time, go back to scenario 2.
Well, we decided to go on, and the next step is to convert the pips of potential loss into money. The loss units themselves do not affect our nerves, but a loss in money is a serious motivator. When calculating, it is necessary to understand that a loss is generated with double volume, since two orders are already open. If we assume that 1000 pips = 1000 USD, we find out that in addition to the already existing loss of 3000 USD we will have at least another 4800 USD. Are you ready to accept a loss of 7800 USD at the highest point? If not, then accept 3,000 of loss and go to scenario 2.
Suppose this loss does not scare us for a few reasons: either we are not afraid of losses in general, and we are prepared for any and every eventuality (which is unlikely), or this loss will be less than 5-7% of capital, and we are prepared to accept. If this figure is more than 30% of your deposit, I strongly suggest following scenario 2.
When the initial calculations are complete and we clearly see what we are challenged with, we go to the second step. The second step means the choice among three methods of adding.
- Adding by means of rented orders
- Adding with fixing a single position
- Adding in the Martingale way
Let’s study all the three ways:
Adding with rental orders
I can’t say for sure whether anyone else developed or applied this method, so I suggest that I’m the author of this methodology. To explain clearer, I introduced term of rental order. A rental order is an additional order that must close if the price reaches the level of the previous order.
Well, to employ this method, we need to perform some more calculations. We shall cover the distance between the last opened order and the expected pivot point by a few intermediate orders.
First, we put the top order (PO Sell 1.79400 (1 lot)). I think you’ve already understood that it is a pending order of Sell Limit type. Next, we identify in the chart the points of possible intermediate reversal between two our orders. It is up to you, how to identify this points. I, personally, don’t invent anything new and find these points in the simplest and most effective way, according to the theory of highs and lows. When you chose these extremes, take into account a few factors:
- The points must be of the same type (I mean, if you take a high of the previous trend as the first point, then the next points can’t be lows, they must also be highs).
- The distances between the extremes must be roughly equal, to calculate an approximate number of intermediate orders
- The distance between the extremes mustn’t be shorter than average daily volatility, so that the orders won’t be triggered by the market noise.
So, when the points are defined, we can calculate the number of additional intermediate orders. Taking into account the total distance that the price can cover, we can place 2 additional orders within the position, according to the internal points that we have figured out.
Now, we need to calculate our potential loss from all possible orders in our position. I explained above how you do it. I’ll just say the final result. Now our potential loss has increased from 7800 USD to 11000 USD. Do we agree with the new figure? If not, go back to step 2.
We put our additional orders in the chart and have a grid of 5 orders; two of them have been already opened, and three orders are pending.
Sometime later, we see that the levels for additional orders have been correct.
The current price is at level 1.78000, so the situation for our position is like this: the price reached the very top order and all the orders opened; so, the total loss for the entire position was 11000 USD at that moment. However, the price reversed and went down. At the level of, the price reached the first rental order, yielding the first intermediate profit from the very top order. It is at this point that the difference between the three methods of adding to a loser becomes clear.
According to my method of rental orders, order (Sell 1.79400 (1 lot)) became rental at that moment, and, according to the rental orders system, we had to close it at the level of the previous order, 1.78300. So we did.
Therefore, we have 4 opened orders, the loss of 4600 USD (it is already almost a half of the maximum), an increase in the account balance of 1100 USD, and consequently, an increase in the collateral funds.
Next, after the top order is closed with a profit, we wait the further price decline. But, keeping in mind that anything can happen, we again put a pending order at the point, where it originally was; it doesn’t matter, if the price will reach it or not. If the price repeats its maneuver, we’ll again receive a free increase in the balance equal to 1100 USD, and so on.
This time, this scenario with the top order hasn’t occurred, and, following a short consolidation at the level around our order 4, the price goes down again and reaches already order 3 at 1.77300, where we closed it at 1000 USD according to our planned scenario, since order 4 has already become rental. The loss is already down to 1400 USD. Why isn’t it 3600 USD? It is because there is already 2100 USD on our balance. It is the profit taken from two rental orders, which we subtract from the total loss. Next, we, according to the strategy, again put a rental order at the previous level and again wait. And here it is, the price in fact starts rising and met out order, after that it again reverses and rolls down to the level of order 3. We again take the profit of our new rental order and, it is now 3200 USD. We subtract is from 3600 USD and get the net loss of 400 USD. And that is with the current price, 2500 pips higher than the previous entry at 1.74800. On the way down, we close another two rental orders, adding to the balance another 2500 USD. Thus, we came to our fixing point with only one open order, which has no loss and is currently at 0 (in fact, it is not, there is a small negative yield due to commission, spread and swap, but they are insignificant, however, you should take them into account, of course). So, there is no loss, but there is a profit of 5700 USD. And the price is at the point of the original opening position. Thus, we received a rather decent profit, without spending anything on it, except for time and nerves.
There is another example of employing rental orders in trading.
As you see from the above chart, a GBPSGD sell position had been opened before a sideways trend started, which at the time of the position opening, of course, was not known. The price decline was expected. But the market, as it often happens, went its own way. The price went up, and at the level of 1400 points above the initial position, I decided to open a rental order to add to the position. Sometime later, the price rolled down to the level of the first position, and I decided to take the profit from the rental order. After a while, the situation repeated itself, and the new order worked out again. And it was so three times. Eventually, I got the initial opening price and 4200 points of more profit, taken from rental orders.
In this example, I described real market situation, where I took part myself. My personal trading strategy suggests employing rental orders sometimes.
Adding with fixing a single position
It makes no sense to describe the entire procedure again, as I’ve done above. I’ll only explain the difference between these two methods.
In this way of adding to a position, you don’t close any intermediate orders, you just expect the final result, and in particular, when the price reaches the initial level of the position opened. The main difference here is in the final result and in something else, which I write about a little later. Well, we don’t close the order in the way, rather, we close all the orders at the same point. And, as a result, we take not 5700 USD of profit, as it was in the first scenario; it is 0 + 1400 USD + 2500 USD + 3500 USD + 4600 USD = 12000 USD. Twice as much as in the first scenario. It would seem that everything is excellent, but there is a but. Let’s analyze the example, where the price, having reached the level of order 2 (Sell 1.76200 (1 lot)), didn’t went lower, but, on the contrary, reversed and went higher, up to the levels of the top order. We get back our loss that seemed to have been covered; it is now 11000 USD. The price has covered a long distance, but the arithmetical result remains the same. In case of a similar scenario with the first method, it is 11000 - 4100 = 6900 USD of net loss. Admit, that such protection is rather helpful.
Adding to a trade with the Martingale way
Martingale is a special gambling system, which implies continually doubling the stakes until the gambler receives a net profit or losses all the funds.
I deliberately presented the historical origin of the term. The definition itself suggests an idea of huge risk, engaged by the method. But it is a rather full and complete risks than just huge. However, constant adding to a losing position engages not only tremendous risk, but a huge potential of profit as well. But first things come first.
The very term Martingale suggests a special way of adding to a single position.
As you see from the chart above, all orders are kept at the same levels as it was in the previous methods, but there is an important difference. Look at the orders’ size. Each following trade twice as much as the previous one: 1,2,4,8,16,32… I believe you understand what the result could be. If you have a deposit, sufficient to add to a losing trade with the first two ways, but you may not have enough money to add to and finally succeed with the Martingale way. The total volume of the entire position in the first two variants turned out to be 5 lots, but with the martingale method this is already 31 lots. The load is very large. Consequently, other parameters will too high. The total loss at the time when the price is next to the top order is no longer 11,000 USD, it is 28,200 USD. How much of your deposit does the trade take? The risk, of course, is tremendous, but sometimes, the profit is worth risking. The profit form the trade will be manifold more, namely, it will be 104400 USD. The profit from the trade will be far more than the invested funds. Rental orders will yield a less profit, but the risk will be far lower as well.
In conclusion, I’d like to add that any way of adding to a position means rather complex calculations, which are easy to make an error. So, if don’t like counting, this way is not for you. A single tiny calculation mistake may result in losing the entire deposit. So, you can take an advantage of the method, but never use, being impulsive and emotional. You will achieve a positive result only provided that you calculate with cool head.
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