This strategy works better for a side way trend or a price movement that oscillates between the resistance and the support line.
I wouldn’t even call this as a ‘system’ because of its simplicity.
The ‘Average Down’ involves buying additional shares (or contracts) when the price declines (vice versa applies for Average Up). Although you will be losing for a moment in a bearish market if you are in a long position, once the price bounces from the support line (that’s why I said this strategy works better in a sideway trend) you profit considerably (only if it bounces back).Thus the capital management is the key to using this strategy —you don’t want to receive a margin call before the bounce-back.
Hypothetical scenario:
(From Investopia.com)
Although the example is for stock trading, the principle applies for forex
For example, suppose that a long-term investor holds Widget Co. stock in his or her portfolio and believes that the outlook for Widget Co. is positive. This investor may be inclined to view a sharp decline in the stock as a buying opportunity, and probably also has the contrarian view that others are being unduly pessimistic about Widget Co.'s long-term prospects.
Such investors justify their bargain-hunting by viewing a stock that has declined in price as being available at a discount to its intrinsic or fundamental value. “If you liked the stock at $50, you should love it at $40” is a mantra often quoted by these investors
The main advantage of averaging down is that an investor can bring down the average cost of a stock holding quite substantially. Assuming the stock turns around, this ensures a lower breakeven point for the stock position and higher gains in dollar terms than would have been the case if the position was not averaged down.
In the previous example of Widget Co., by averaging down through the purchase of an additional 100 shares at $40 on top of the 100 shares at $50, the investor brings down the breakeven point (or average price) of the position to $45:
100 shares x $(45-50) = -$500
100 shares x $(45-40) = $500
$500 + (-$500) = $0
If Widget Co. stock trades at $49 in another six months, the investor now has a potential gain of $800 (despite the fact that the stock is still trading below the initial entry price of $50):
100 shares x $(49-50) = -$100
100 shares x $(49-40) = $900
$900 + (-$100) = $800
If Widget Co. continues to rise and advances to $55, the potential gains would be $2,000. By averaging down, the investor has effectively “doubled up” the Widget Co. position:
100 shares x $(55-50) = $500
100 shares x $(55-40) = $1500
$500 + $1500 = $2,000
Had the investor not averaged down when the stock declined to $40, the potential gain on the position (when the stock is at $55) would amount to only $500
Hopefully, you get the idea. Again, if you think the market is likely to break the support or resistance, be cautious of using Average Up/Down.
Capital management is the key.: start small (perhaps 0.1 lot), then you roll the snow ball.
I will be following up the topic by putting some screenshot of my trading performance using Average Up/Down.
P.S.: I’ve just adopted this strategy not long ago and have made a consistent profit using it. You are welcome to raise questions, doubts, or point out the flaws, or make constructive suggestions regarding Average U/D.
Happy trading!
