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In order to reduce the average cost per share for a security, traders sometimes apply a technique called Averaging Down (scale trading).
The strategy consists of buying additional shares of a stock at lower prices than the first entry price. For example, a trader buys 1000 shares of Google at $600. If the price of Google drops by let us say 10%, the trader will buy more shares (A percentage of the initial number of shares) of Google at a lower price ($540). The advantage of using this strategy is that after a scaling in (Buying additional shares of an owned stock), the overall cost of purchasing a stock (The average entry price per share) is lowered.
A lot of traders use the averaging down strategy, however many others believe that it breaks a fundamental rule in trading, which is to cut losses and let profits run.
The current money management script contains the Averaging Down strategy logic and it can be applied to any trading system. In the money management input grid, you can select the threshold that beyond which a position will be scaled in and the ratio factor that will be used to determine the number of shares to buy or short in the scale in order. The number of shares is calculated by multiplying the current number of shares by the threshold value and then by the factor value. Example: We hold a long position of 1000 shares of Apple and we have set the strategy threshold to -5% (-0.05) and the ratio value to 3. The share price of the stock drops by 5% and a scale in is initiated. The scale in order will buy (1000*0.05*3) or 150 shares.
This Averaging Down strategy works with long, short and long/short trading strategies.
Trading financial instruments, including foreign exchange on margin, carries a high level of risk and is not suitable for all investors. The high degree of leverage can work against you as well as for you. Before deciding to invest in financial instruments or foreign exchange you should carefully consider your investment objectives, level of experience, and risk appetite. The possibility exists that you could sustain a loss of some or all of your initial investment and therefore you should not invest money that you cannot afford to lose. You should be aware of all the risks associated with trading and seek advice from an independent financial advisor if you have any doubts.
