The Dangers of Averaging Down

Why is averaging down dangerous and why is the probability of bankruptcy high
I wrote down my thoughts

First, whether I will average down or not
The answer is: not

I will never do this

However, I may take additional positions

Here, I will explain the difference between averaging down and the additional position making that I am doing.

Averaging down is taking on an initially unplanned position
Additional position making is taking positions that are planned from the initial stage

They may seem similar, but they are completely different, so I’ll give a simple example
Person who averages down: Mr. A
Person who does not average down and plans from the start: Mr. B
Both are looking at the USD/JPY chart at 110.30 yen
Trading environment is exactly the same
On a exchange with 500x leverage
Both have 100,000 yen capital
Lot size up to 350,000 currency units; MT5 shows 3.5 lots
Max up to 450,000 currency units, but due to forced liquidation we cap at 350,000

※ And both usually trade around 100,000 currency units (1 lot) ※
↑This is important↑
This is just an example
Please stop the serious question of “Your lots are too high” and笑

First, Mr. B who does not average down
From 110.30 yen, he plans to buy
If it goes down, he plans to buy gradually down to 109.95
The plan is
Buy 0.33 lots at 110.25
Buy 0.33 lots at 110.15
Buy 0.33 lots at 110.05
Total 0.99 lots
Average fill price up to this point is about 110.15

Stop loss at 109.95

Result
He managed to buy everything, but
the price continued to fall and hit the stop at 109.95
Loss: 20 pips
Loss amount: 20,000 yen

Next, Mr. A who averages down
Here I will explain Mr. A’s emotions during trading (this is my subjective view)

Without any particular plan, simply because it dropped to 110.25, he buys 1 lot
Then it drops to 110.15, with unrealized loss of 10 pips
Disliking losses, he buys another 1 lot

Then it drops to 110.05
Unrealized loss: 15 pips
Desiring to recover, he buys another 1 lot

The downtrend strengthens and it reaches 109.95,
Stop loss
Loss: 20 pips
Loss amount: 60,000 yen

Both trades ended with a stop loss

Comparison
Loss in pips: both of them 20 pips
Loss amount: Mr. A 60,000 yen
Mr. B 20,000 yen

Total lot sizes
Mr. B trades about his usual 0.99 lot (approximately 1 lot)
Mr. A trades three times that, 3 lots

Now, consider why the outcomes differed even though capital and chart direction were the same

I think it lies in trading strategy
The key difference between planned additional buying and averaging down is emotion
Mr. B plans for where to add if the price falls, and when to cut losses from the start at 110.30
He spreads risk and limits risk
Risk diversification means, as used here, spreading out the usual 1 lot into increments
Limiting risk means considering how much money you could lose when a stop is hit and understanding it

This is essential behavior for traders

So, did Mr. A do this?
Because his trading was unplanned, he impulsively buys 1 lot at 110.25 as usual
The price falls further, and since he dislikes losses, he immediately buys another 1 lot as usual
Then it falls again, and he thinks, I just want to end with at most break-even, so he buys another 1 lot

Now the price reaches 109.95, so he stops out
If you notice, he has a 60,000 yen loss

Did Mr. A anticipate that a loss of 60,000 yen would occur when he placed the first 1 lot?
Probably not
And what about Mr. A’s emotion when he entered the last lot?


I want to end with at least break-even because I don’t want to win
Did Mr. B have that emotion?
He does not
Not at all

Because he had already anticipated the price could fall to that level from the start
It’s not exactly “mental preparation,” but by preparing,
you can view the chart calmly without getting emotional even during a decline

I believe this calm is very important

Trading involves planning a strategy, thinking a lot before trading,
and I believe that execution and then setting stops and take-profits and leaving it alone is often fine


If averaging down and trading goes poorly for you
Make it possible to cut losses with emotionless discipline
If needed, reduce the lot size and make other adjustments

If you still cannot cut losses
Set a stop loss and never shift it toward increasing losses

If you cannot set a stop loss
Study technical analysis
Dow Theory is recommended, and Fibonacci retracement helps place multiple key horizontal lines for effective stop loss setting

Expected vs unexpected
Price action is also crucial

Expecting the unexpected helps you read charts calmly

The problem is the unexpected
When you watch the chart, there are often moves you did not expect
For swing trading on weekly/daily charts
For day trading on 4-hour and 1-hour charts
For scalping on 5-minute and 1-minute charts

If you hold a position when this happens
Common emotional responses and actions are: you cannot cut losses
Fear of a loss
Wanting to avoid losses
This is natural for humans

But if, from the moment you take the first position, you already know that a loss will occur, would you not cut losses without hesitation?
This is what we call an expected loss
It means limiting risk
This is Mr. B’s approach

Unexpected moves are price actions that suddenly drop
But this is a matter of interpretation for each person


Strangely, even though both watch the same price action,
Mr. A thinks, “Oh no, it dropped suddenly, this is bad, I’m in the red”
This is an unexpected move


Mr. B thinks, “I see it dropped to this point, I understand why”
This is expected movement

What do you think?
Even just by looking at this blank space, can you read their emotions to some extent?
An emotional person vs someone still calm



And now, although we deliberately cut losses at the same point this time,
In the worst case, Mr. A might not be able to cut losses here
There is a possibility he will average down even more

Since their goals are different
Mr. A wants to minimize losses and reach break-even

Mr. B accepts the loss as a natural part of trading and moves on


Now, notice something interesting
If Mr. A's goal is break-even, he might not need to trade at all and would stay ahead


The importance of planning is here
Both started trading aiming for profit
However, if you chase only profits in every trade, you are highly likely to become emotional

Because you don’t want to cut losses, you think and act accordingly
Averaging down is exactly this
You want to profit but price declines

You want to take profit even a little, so you average down, but it declines

Oh no, unrealized loss is bad; I just want break-even to survive; so you average down

And then it declines further; stop loss
At this point, Mr. B's loss is three times larger
In other words, while he usually trades 1 lot, now he has three times the loss



If you have a plan at the start and execute it
you will not incur losses beyond your plan

You’ll even come to see stop losses as a cost

If you do this, it’s better to thoroughly study ways to profit even when using averaging down
If someone tells you that your funds are gone or that you don’t matter, there is nothing I can say in response.

Even billion-dollar traders did not start with billions of capital
The devil’s whisper that you can make quick money by boosting lots is something you should ignore, endure, and fight with properly sized lots


Market adage
“First, survive. Winning comes after.”