- What is position averaging in trading?
- Why Position Averaging Works Best in Forex?
- When the averaging strategy is profitable?
- Carry trade and averaging strategy in Forex
- Algo trading using averaging
- Effective money management when averaging positions (risk control)
- Calculation of the price movement using the indicator
- Algorithm for calculating the risk for the average position
- Excel spreadsheet for calculating the risk of knee averaging
- Pip value calculation formula,
Max Gunther’s popular book Axioms of a Stock Market Speculator has an entire chapter on position averaging strategy. From his point of view, this is the main evil and a manifestation of excessive greed in trading. However, the axioms, despite their popularity, were written long ago and did not take into account rapidly changing markets.
Today, averaging trading positions can provide an edge in speculative markets. But the question of when and how to use it remains open. It’s time to dot the i’s.
What is position averaging in trading?
The principle of averaging is simple, traders do it all the time. Someone consciously, relying on their strategy or fundamental factors, and someone unconsciously. An open position (buy / sell order) eventually goes into plus or minus, but while the order is open, everything seems to hang in the air, and at any moment the profit can be replaced by a loss.
When we open an additional position, we get the average value of the asset. If we do this when the order is in the black, then we will get the “pyramid” strategy or the classic build-up of a profitable position.
An example of “pyramiding” in trading: at the beginning of December, three orders were opened with a difference in time and points. A pullback from the main trend was used as a signal. As a result, we got the average cost of EUR / USD equal to 1.10870, the number of lots is 0.03 and the profit is 700 points.
If a losing position is averaged, then we get the classic averaging, which is most often used by long-term investors.
An example of averaging a losing order: at the end of November, two orders were opened with a difference of 60 hours. The second order is opened after the breakout of the resistance level. The asset price after averaging is 1.10106, the number of lots is 0.02 and the profit is 450 points.
In the history of any trader, you can find a lot of similar examples, but the most common result of averaging is a deposit drain. Why? The reason is that the method is used incorrectly and out of place.
As you know, most traders are approximately 95% unprofitable, and only about 5% are trading profitably, based on inside information provided by one of the forex brokerage companies, most of the 5% of traders use the averaging technique to some extent.
Why does position averaging work best in Forex?
The whole secret is in the “nature” of the foreign exchange market. Its pricing is 80% dependent on the decisions of large banks and 20% on speculative transactions. Each country is fighting for the strength of its currency. It is not beneficial for anyone to have a weak national currency, but in this struggle there will still be losers.
However, for a trader, the opposition of different national currencies to each other’s hands. Thanks to this confrontation, price corridors are created in which you can earn money.
And while it is difficult for banks to stick to the middle ground, they will still try to regulate pricing with their leverage. Firstly, this confrontation cannot be stopped, and secondly, it has a beneficial effect on the country’s economy.
Levers influencing the value of the national currency:
- Control of the credit rate – at a low rate, the currency weakens, at a high rate, it gains strength
- Buying or selling nat. currencies – also affects pricing. Most often, investors use the “buyback” nat. currency for short-term investments
- Unexpected statements by officials about changes in monetary policy are mainly calculated for a short-term effect. Panic among speculators can seriously change the value of a currency.
Traders can only catch deviations from the average values and use this effect in their trading.
When is the averaging strategy profitable?
For each currency pair, the structure of the corridors is different, but this is the secret of successful trading. In Forex, it is easiest to see such corridors and use the tactical elements of a trading strategy. One of these elements is position averaging.
In the long run, the averaging method works for 5 plus. However, the use of averaging without fundamental analysis can lead to sad consequences. Yes, it is impossible to take into account all the fundamental “beacons”, but the use of averaging can seriously increase the profit.
For example, the Fed rates. This fundamental factor influences the pricing of all speculative markets. With a “healthy” economic situation in the country, the rise in interest rates contributes to the strengthening of the national currency, and vice versa. Therefore, following the dynamics and fundamental prerequisites for the change in this indicator, we can assume the mid-term direction of the trend.
Carry trade and averaging strategy in Forex
Let’s consider the use of fundamental factors in the popular carry-trade strategy, in which the averaging of positions becomes most effective. The main task of the strategy is to trade assets in the direction of the trend, and if the asset also has a positive swap, then we will get an additional profit.
With this approach, you can use most of the classic oscillators (MACD, Momentum, RSI …) or the modern iPump, which shows overbought / oversold zones, trend, and trading levels, which together gives a complete picture of the market.
Features of the approach to “Carry-trade” with averaging:
Trades are opened for those currency pairs in which the trend direction coincides with a positive “swap”.
Fundamental factors and the current trend should support the order opening.
The trading pair should be flat, with a corrective pullback of more than 40%.
Averaging can be implemented using several money management approaches:
Using the same lot for each tribe
The use of increasing lotage in each sl. warrant
Personal recommendation to increase the lotus by no more than 1.3 from the previous order. This approach will reduce the necessary price pullback by bringing the profitability zone of orders closer.
Algo trading using averaging
Trading in the auto mode can be considered as an alternative option for averaging using the Forex Expert Advisor Pump and Dump. It is important to understand the averaging itself – this is just a money management option, the entry points to the market are taken based on certain indicator signals, within the Pump and Dump Expert Advisor this is the iPump indicator. An important point is that the EA contains a code that cannot change depending on the situation. This reduces the flexibility of decision making, and hence the number of profitable trades.
For more effective control of the advisor’s work, it is recommended in parallel to monitor the traded currency pairs and analyze the fundamental and technical picture of the currency pair in order to adjust the advisor’s work at the right time.
Effective money management when averaging positions (risk control)
Money management is the cornerstone of trading, its foundations originated thousands of years ago in Babylon (the book “The Richest Man in Babylon”). But today, for different markets, they use a different level of risk. Moreover, scalpers love aggressive methods, while long-term investors elevate classical risk control to the absolute.
When averaging positions in the forex market, it is catastrophically important to correctly calculate the money management of positions.
Calculation of the price movement using the indicator
Let’s consider an approach using the Average True Range volatility indicator, in the lane. from English Average True Range, or ATR as most traders know it.
To see the expected price movement and thereby approximately calculate the potential risk of a position, you can view the values of this indicator, and understand the potential price movement against us within 1 day, as well as within a week and a month. This gives very important information about the perceived risk for calculating money management. It is these indicators, as accurately as possible, that show the potential risk (Stop-loss) for the entire series of orders.
Algorithm for calculating the risk for the average position
Based on the daily / monthly ATR, it becomes clear how many pips the price can potentially go against us, depending on this, we can calculate the entire risk that the position will bear in the event of a negative price move against us before opening a deal. For the calculation, let’s take the EURUSD pair, the lot increase factor is 1.2. As of 01/23/2020, the trend for this pair is downward, the swap for short positions is positive.
Excel spreadsheet for calculating the risk of knee averaging
Pip value calculation formula
This value is calculated by the formula:
PointValue = (ContractSize * (Price + PointStep)) – (ContractSize * Price)
Using the EURUSD pair as an example, we can calculate that: PointValue EURUSD = (100,000 (size of 1 contract) * (1.1090 (actual price) +0.0001 (minimum change in quote) – (100,000 * 1.1090) = 10 USD price of one point …
Using the example of WTI crude oil, we can calculate that: PointValue WTI = (10 (contract size) * (62.40 (current price) +0.01 (minimum change in quotation) – (10 * 62.4) = 62.41 -62.4 = 0.1USD (10 cents) price of one pip.
It is worth remembering that averaging on Forex can lead to negative results even with the use of fundamental and technical analysis. But this is the risk that every trader takes.
When should you refrain from averaging a position?
- when there is no clear understanding of the position risk calculation
- not having an effective indicator that allows without subjectivity, and therefore automatically determine the trend, levels, overbought / oversold zones (iPump, MA, RSI indicators will help you);
- with a high coefficient of increasing the lot (more than 1.3).
By following simple rules, risk control and the “right” analysis tools, you can achieve good results when averaging positions.
The Pump and Dump Expert Advisor has a built-in level indicator, as well as the ability to average a position according to the concept described in this article.
Pump and Dump Expert Advisor