Adding positions to an open trade is an advanced trading technique that, although potentially risky if not done correctly, can magnify profits exponentially. But just like every other aspect of trading, this technique can have a strong psychological effect that may hinder your trading performance.
Adding to Losing Positions
Whether you’re “averaging down” on a long position or “averaging up” on a short position, adding to a losing position is a technique that we don’t normally recommend noobs take on or attempt, especially live, until they have their risk management discipline down cold.
Some may argue that adding to losing positions improves their average price when they enter a trade too early, which is a valid argument, but this action tends to bring in one of the most potentially dangerous mindsets to have when trading: hope. Hope tends to creep in and can be a negative influence on your decision making process when you don’t plan ahead, and this is especially true when adding to losing positions. Instead of taking a step back and reassessing the position objectively to find out why it’s a loser, traders may turn a blind eye to the current conditions and HOPE that the market will turn back in their favor once they’ve committed to getting bigger in the trade. Needless to say, doing this often and running into a string of stopped out trades can lead to huge losses when positions are arbitrarily stacked up.
“Hope” and “scaling into losing positions” can be a combo that’s very hazardous to your trading account, but you can avoid that pitfall by pre-planning your max risk, entry & exit levels, and position sizes–you know, stuff you’re supposed to do with every trade! :p If you’re unsure on how to do so, then be sure to check out our guidelines for adding to losing positions found here.
Adding to Winning Positions
Not only do successful traders let their winners run, but they maximize their potential profits by adding to their winning positions when the market environment calls for this technique to be employed (ie. Trending and/or momentum market movements). Maximizing potential profits is always “awesome,” but this trading technique can bring on its own psychological issues.
Now, if you follow our guidelines to scale into winning positions, then you basically know how to create trades with limited risk and high reward-to-risk potential. How can anyone have issues with that?
Well, if you add on more to your position and it goes against you, that profit could vanish faster than you made it. This is when one of the most difficult psychological issues, in my opinion, for noobs to get over kicks in: the fear of “turning winners into losers.”
The fear of loss can be very motivating: the fear of losing your job may motivate you to work harder; the fear of losing your hand will most likely cause you to not pet alligators or sharks; the fear of losing his lady love propels Cyclopip to shower at least once a week!
In trading, the fear of “a winning trade turning to a loser” is a powerful one which often causes noobs and experienced traders alike to cut out of a trade much too early and miss out on a really big profit. As difficult as trading is, we really can’t miss out on any of those.
Again, this mental block from holding onto winners is a very difficult one to get over, but not impossible. By practicing this technique many, many, many times through price action/system reviews, and applying it on demo, you’ll gain the experience and statistical support needed to give you confidence when executing on a live account. And it doesn’t hurt to think as my buddy Pipcrawler thinks when he says, “You gotta risk it to get the biscuit,” right?
So, stop wasting time and start practicing your scaling techniques to avoid emotional hang ups, and if you want some examples on how to properly manage you risk while adding to your position, you should check out the FX-men blogs as some have given a step-by-step guide on the best scenario possible for maximizing profits on certain trades. I hear that Pipcrawler, Cyclopip, and HappyPip were inspired by my entry on deliberate practice, so they have a bunch of good blog posts on past price action. Check’em out and then figure out how you could add to open positions in a way that works best for you…Good luck!