Wednesday, January 06, 2010

Is It Proper to Add to Losing Trades?

There was some unintended but useful controversy generated by my recent post on trade management. The question is whether it is ever permissible and prudent to add to a trade that has moved against you since your entry.

My response to this is that I know very successful traders who add to positions at more favorable prices, and I know many successful traders who never do this.

What's clear is that adding to a trade *because* it's in the red--simply as a way of trying to bail out a loser--is a risky and ill-advised strategy. Such a trader is adding to the trade more for psychological reasons than logical ones.

There are times, however, where I will enter a trade with one unit (in my case a half-sized position) and will add a second unit if the market gives me a better price *and* if I see that the move against the first unit is losing steam. If the whole trade gets stopped out, I can easily live with the results, because two units is not a high level of market exposure for me.

What's key is that, in such a scenario (and they are not common in my own trading), I'm adding because I see opportunity and a shift in market strength/weakness that can benefit me. I'm not adding to the position in order to be made whole on a loser. Indeed, I don't view such a trade as "adding to a loser". The trade is only a loser if I'm stopped out by planned criteria. Rather, I'm adding to a good trade at a better price.

But I never add to losers, in the sense of adding to a trade that has hit my planned stop out point. It is often such small exceptions from discipline that lead to far larger and costly ones--much like cheating on diets!



zircon-212 said...

AHA even the good doctor tries to redefine "adding to a loser" ....It is one of trading greats philosophical discussions and brings out huge emotions on both sides. Adding unit size, scaling in, or _____fill in the blank definition.....if you add to a position that is out of the are adding to a losing position. Take a poll and find out what technique (or lack there of) led to a traders largest loss. My money is adding to a loser tops this list by a wide margin

Arie Blum said...

Dr. Brett,
I understand that your total number of units is 4. You often talk about a 1 or two unit trades. When do you trade your full size? Would it be a situation where you are adding on a pullback? Are you buying above certain levels?

Thanks for all once again!

jgpietsch said...

Another consideration may be whether you are taking the trade as a trend or mean-reversion set-up. Easier to argue for building for the later, in my opinion. All the best, Jeff Pietsch

Radek Dobias, H.B.Sc., M.W.S., B.Ed. said...

I noticed over the years that in various disciplines (trading, chess, poker, art, writing..etc.), there are two kinds of guidelines that guide one's thinking and action: rules and principles.

Rules are inflexible and specific.
Principles are flexible and broad.

For beginners, rules are normally excellent. They ensure that one does not commit serious blunders.

However, once more understanding is developed through practice and reflection, one begins to understand how to apply principles in a variety of situations (which sometimes means breaking rules!).

I think your reflection illustrates that. Adding to a losing position is, generally speaking, a losing proposition. It is a good rule to follow. Yet, there may be a principle which, when properly applied, allows one to do that profitably, as you illustrate.

Investidor Ninja said...

It depends…

In Brazil, especially in the index futures market there were some structural changes in mid-2009 that allowed the use of High frequency Algos (e.g. co-location). As we all know Brazil’s market tend to follow the mood in the US especially in the opening, when markets here followed the S&P futures to the tick.

However with the big money heading straight to the HFT markets here have become more “Wild”, with bigger swings than before but still in the same mood of the US markets, those big swings can (most of the times) offer good trades in the opposite direction.

The problem is “how big are those swings” so I must keep adding to my losing positions until markets here revert…(or I get stopped)

Pete said...

nice post dr. b - such an important post(to me at least). adding to losers is my demon. i know im not alone. i too usually work in units up to 4. some reason im much more aggressive w/ sizing in fading vs trending plays.

my fades i can usually score a win rate in the 70% range, about 20% scratches, 9% losses, and 1% of my fades turn into major hits wiping out weeks of grinding. with a higher win rate it's hard for me to accept i wont win on every trade and battle/aka average. many i get out scratch/small losses/small wins. it's that 1% that does serious financial and emotional damage.


Gustavo's Trades said...

I would suggest reading or listening to the audio book "Reminiscences of a Stock Operator" this problem is as old as the markets in itself. Back in the days, after making is first million, Jesse Livermore made a fatal mistake by adding to a loser and trying to corner/support the market that was failing on him, costing another trip to the poor house.

Bottom line, what is your system? Have you tested? If you're adding when you're down, do you have other metrics to support your hipotesis that the market is simply retracing against you? And, most important of all, where is your STOP?


Chris said...

Dr. Steenbarger-

I'm happy you brought this up again. I discussed this last night with my brother (a spread trader at a different firm), and we came up with a couple of different ideas re: When it's acceptable to add to a "loser":

First off, the answer we came up with was (again) you should never add to a loser. What's a "loser"? Well, that's simple - it's your initial trade, in whatever form. It's your initial open position.

Here's the caveat: Sometimes, your "trade" is not complete until you get what you need to get. Say my "trade" is to buy 100 NQ's. I could just put my bid out there for 100, hope I get filled (and likely run through), then sit on my hands. OR, I can put 25 NQ's on each of 4 ticks. Buying 25 NQ's 1 tick lower than the prior 25 is not adding to a loser - it's just me trying to get into my full position in a reasonable fashion. This happens all the time, especially when your size is such that you cannot reasonably enter and exit full positions on the bid or offer.

That being said, I stand by what I said (and what others have seconded) - that you should never, ever add to, double up on, "average into", etc. a losing opening position.


Pete said...

marty schwartz in his book 'Pit Bull'had a good 'add to loser' plan when a loss got out of control past his stop - double up right next to your puke point- and still take the stop at the puke point for all.

gustavo- ive read it ROASO 12 times. Easy to quote, hard to do.