This is a sensitive topic, often provoking a lot of bad memories and experiences in the stock market as well as in life. But this topic needs to be answered Who knows it might be an interesting read and give you a lesson or two on life in general along with your trading.
First and foremost if you have done this, averaging a losing position that is, then don't feel bad about it, you need not beat yourself up on this, trust me it is not your fault. There are very deeprooted reasons for this type of behaviour, which are seldom addressed. People only point to this problem, that too after the fact (that is a b big loss) but never really give you the reasons behind them...
Today we will change that, so are you with me on this? Yes, let's get started then...
Well, if you have been trading for a while then you don't need any introduction to this devil. But if you are just starting out and haven't yet looked under the bed this is the monster you must know beforehand...
Let's say you are bullish on a particular stock of your liking, be it Apple or Reliance or even Crude Oil (commodity future) and you come in and buy. The stock moves in your favour for a bit but quickly starts giving up ground.
You get that lump in your stomach once again, that familiar but unwanted feeling sets in again, what if this one turns out to be a loser too... Don't be shy, we all have gone through this, right? Ok, let's move on...
Now the stock goes below your purchase price, now you are surer that this also is going to go down the drain and you actually start hoping for it to be a loss... As it painfully inches towards your stop-loss, the feeling becomes more unbearable and this is the time you make the biggest mistake, no it's not averaging your position, that comes later, what comes first is even more troublesome, with me so far???
via GIPHY
As soon as the feeling of loss becomes unbearable, you run back to your charts...
You try to assess whether your analysis was correct?
Did you consider all the factors?
Was your conclusion of higher prices a valid one?
And the final nail in the coffin, is the analysis still valid?
No surprise for guessing what happens next, you find out that everything is still valid, prices should still move higher, only that they are moving lower right now, but higher is where they have to go, sooner than later...
Now say you bought at 100 shares of your stock at 500 and put your stop loss at 450, the stock is trading at 465. With your analysis being "re-verified" by "you" (I mean who cares for the confirmation bias, more on that later...) 465 is a bargain price so you double up on your original position, that is you buy another 100 at 465, now your average price is 482.5...
Now the stock only has to rise by 17.5 bucks instead of 35 bucks for you to come at breakeven...
Does this sound familiar? I know I have done that, so I am saying yes this shit happened with me...
Well, you still hold on and it continues to move higher and get to your original target and you make more than double the profits. It's a happy ending, don't you think?
And surely, the market being the tough taskmaster goes down and hits your stop-loss at 425, now how much did you lose, a grand 11500.
So as you can see, it works out for you in only 1 of potential 4 to 5 scenarios. The odds say you can win only 20-25 % of the time and even then a good exit is not guaranteed. But enough of this day-dreaming I say, let's look at the underlying reasons behind this problem after all that is what you want to know right???
Let's now look at some of the possible reasons or causes behind this self-destructive behaviour, some you may find useful, some you may not like. But remember that is why so many people are still facing this issue, they refuse to accept the real reasons behind their repetitive failures...
It is "heroes do not give up"... and we all want to be heroes, I mean who does not want to fly like Superman, I know I do, fu*@#ng gravity...
Our heroes fight till the end, often sacrificing their lives for a cause. This has been ingrained in our psyche from a very young age, and this is a difficult belief to shake off. We often feel guilty when we leave a project halfway, unfinished. We all have to complete our homework. The list goes on and on...
It is exactly opposite in trading, if you are in trouble, just run, run away, come back the next day, the market is not going to go anywhere...
Similarly, whenever "you" find out a trade it becomes "your" trade, as if you are going to grow old together, not everyone is Warren Buffet and Coca-Cola...
This has a name in behavioural science, confirmation bias, in simple words, we tend to attach far more confidence and importance to something which we have discovered or something which is happening to you. But at the end of the day, it is just another statistical event, it does not carry any special importance...
Re-verifying your analysis does not make it more correct or wrong, it just gives you a feeling of doing something, something which is not at all necessary...
But we tend to forget that, a trade entered is nothing special, it is just another trade, even your stop-loss is just another stop-loss, there is nothing special, let it hit, if markets don't want to conform to your analysis. Take the hit and come back the next day, surprise surprise, markets are still going to be there...
If you want to control markets, stop reading and go back to controlling the markets, you should not waste any more time here, you have taken up the biggest responsibility in the world, trying to control everyone else... yes, you thought right, does not happen!
But if you want to control your behaviour in certain situations, well there is hope. It is difficult but still possible, you need to be ready to put in some effort. Luckily there is a method you can follow...
First and foremost if you have done this, averaging a losing position that is, then don't feel bad about it, you need not beat yourself up on this, trust me it is not your fault. There are very deeprooted reasons for this type of behaviour, which are seldom addressed. People only point to this problem, that too after the fact (that is a b big loss) but never really give you the reasons behind them...
Today we will change that, so are you with me on this? Yes, let's get started then...
Averaging Your Losers - What does it even mean?
Let's say you are bullish on a particular stock of your liking, be it Apple or Reliance or even Crude Oil (commodity future) and you come in and buy. The stock moves in your favour for a bit but quickly starts giving up ground.
You get that lump in your stomach once again, that familiar but unwanted feeling sets in again, what if this one turns out to be a loser too... Don't be shy, we all have gone through this, right? Ok, let's move on...
Now the stock goes below your purchase price, now you are surer that this also is going to go down the drain and you actually start hoping for it to be a loss... As it painfully inches towards your stop-loss, the feeling becomes more unbearable and this is the time you make the biggest mistake, no it's not averaging your position, that comes later, what comes first is even more troublesome, with me so far???
A bigger mistake...
via GIPHY
As soon as the feeling of loss becomes unbearable, you run back to your charts...
You try to assess whether your analysis was correct?
Did you consider all the factors?
Was your conclusion of higher prices a valid one?
And the final nail in the coffin, is the analysis still valid?
No surprise for guessing what happens next, you find out that everything is still valid, prices should still move higher, only that they are moving lower right now, but higher is where they have to go, sooner than later...
Now say you bought at 100 shares of your stock at 500 and put your stop loss at 450, the stock is trading at 465. With your analysis being "re-verified" by "you" (I mean who cares for the confirmation bias, more on that later...) 465 is a bargain price so you double up on your original position, that is you buy another 100 at 465, now your average price is 482.5...
Now the stock only has to rise by 17.5 bucks instead of 35 bucks for you to come at breakeven...
Does this sound familiar? I know I have done that, so I am saying yes this shit happened with me...
What happens next?
There are a few scenarios that may play out here let's get through them one by one...1. Stock moves higher...
Lucky you, your stock to moves up, you reach breakeven in a jiffy that is at 482.50. Now you are torn between getting the hell out of my position or staying on to get more profits. That is a valid confusion, if you have been in this predicament, again you are not alone, at least I have been in the same position more than once... So you hold on and the stock comes back to 500, your original entry price, now you have a nice profit too, what do you do?Well, you still hold on and it continues to move higher and get to your original target and you make more than double the profits. It's a happy ending, don't you think?
But only if life had been so far...
2. The stock moves lower and hit your stop loss at 450...
That was bad right, you stood to lose 5000 but you end up losing 6500. But you could have done even worse, try the following scenario...3. You move your stop-loss further down, to give room to your new trade...
You just bought at 465, now you have been trading for a while and you know that if you bought it at 465, you need to give it a little more wiggle room than just 15 points, after all, you now have a potential to make double the profits, so you move your stop-loss to 425...And surely, the market being the tough taskmaster goes down and hits your stop-loss at 425, now how much did you lose, a grand 11500.
So as you can see, it works out for you in only 1 of potential 4 to 5 scenarios. The odds say you can win only 20-25 % of the time and even then a good exit is not guaranteed. But enough of this day-dreaming I say, let's look at the underlying reasons behind this problem after all that is what you want to know right???
Why traders average their losing positions? Reasons...
1. A hero fights till the end...
Go back and read all our mythological stories, all the stories that our grandparents told us, all the heroes in our history, there is one common thread... Well before that, even consider the movies that we have watched, there is a common message there too... What is that?It is "heroes do not give up"... and we all want to be heroes, I mean who does not want to fly like Superman, I know I do, fu*@#ng gravity...
Not giving up, has led to the fall of many mighty traders. - Dean
Our heroes fight till the end, often sacrificing their lives for a cause. This has been ingrained in our psyche from a very young age, and this is a difficult belief to shake off. We often feel guilty when we leave a project halfway, unfinished. We all have to complete our homework. The list goes on and on...
It is exactly opposite in trading, if you are in trouble, just run, run away, come back the next day, the market is not going to go anywhere...
2. Confirmation bias...
People tend to celebrate their birthdays as if they had something to do with it... they didn't, but it is still "their birthday": at the end of the day, right?Similarly, whenever "you" find out a trade it becomes "your" trade, as if you are going to grow old together, not everyone is Warren Buffet and Coca-Cola...
This has a name in behavioural science, confirmation bias, in simple words, we tend to attach far more confidence and importance to something which we have discovered or something which is happening to you. But at the end of the day, it is just another statistical event, it does not carry any special importance...
Re-verifying your analysis does not make it more correct or wrong, it just gives you a feeling of doing something, something which is not at all necessary...
But we tend to forget that, a trade entered is nothing special, it is just another trade, even your stop-loss is just another stop-loss, there is nothing special, let it hit, if markets don't want to conform to your analysis. Take the hit and come back the next day, surprise surprise, markets are still going to be there...
3. Wanting to be in control all the time...
That is possible, depending on what it is you are trying to control...If you want to control markets, stop reading and go back to controlling the markets, you should not waste any more time here, you have taken up the biggest responsibility in the world, trying to control everyone else... yes, you thought right, does not happen!
But if you want to control your behaviour in certain situations, well there is hope. It is difficult but still possible, you need to be ready to put in some effort. Luckily there is a method you can follow...
Steps to counter psychological impulses...
- Start keeping some records while putting on trades, like why did you enter, where were you planning to exit, what was your stop-loss, etc.
- Also, add what were your feelings while entering and exiting. For instance, I used to suffer "from fear of missing out" so would enter impulsively. Also, I used to feel anxious with profitable trades and used to exit prematurely...
- Then do a logical analysis and find out what are the supporting beliefs and feelings for your situation, like when you feel anxious about your accumulated profits to think about your plan.
- Then note the effects this changed behaviour has on your trading results, which does not mean trading profits, I am talking about how well you adhere to your plans.
- Then reinforce positive impact beliefs and keep removing negative impact ones.
Conclusion
So these were some of the reasons why traders average their losses or take some decisions which look completely devoid of logic. But this situation can be corrected with some well-directed efforts on your part.
If you have some questions in this area, and I am sure you must be having a ton of them, please put them in the comments section below and I shall get back to you immediately. Also, if you find some value in this post be sure to share it with your friends and colleagues so they can benefit from it because...
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