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!