It is important to always seek confirmation before taking a position for Forex Traders. This is also true when adding to the existing position when placing in the initial position.  There is one thing in all financial markets, it is never add to a losing position.  That means never “average down” a losing long position or “average up” a losing short position.  This is even more important when using leverage.  There is a very well-know saying, “your first loss is your best loss.”  What this means is you are best served taking a small loss before it becomes a larger loss, or even worse, a loss that eats up a majority of your trading capital. 

In order to avoid this major trading mistake, we must first understand why traders add to losers, why traders should not do this, and what they can do to stop it from happening.

Why is it said to be never add to a lose position

When a trader is in a losing position, the market inform him about he is on a wrong position. The market is the sum total of psychological, technical and basic knowledge. The market is the sum total of all investor knowledge and market ideas. These include Institutional money, sovereign wealth fund, hedge fund managers, trend following funds, business hedging interest and every participant large and small.

If a trader maintains a losing position after being told that the market is wrong, the trader is basically right in saying that the sum or the remaining market is wrong. In other words, the global consensus is that the world is round for the trader, while the trader insists that the world is flat. This can always lead to huge losses. Bullish markets tend to trade higher, and bear markets tend to trade lower. That market requires a substantial base or technology to change the trend.

Example:

As traders are losing money, they figure that if they add to the losing position, they can bring the average cost of the position down.  For example, let’s say a trader wants to be short Crude Oil and he sells 1 contract of Crude Oil at $75.00.  Crude is now trading at $80, and the trader is down $5 in crude ($5000).  The trader then decides to sell short an additional 2nd crude oil contract at $80.  The average short position is $77.50 (the average of $80 and $75).

The trader now only needs Crude Oil to go $2.50 in his favor to get to breakeven at $77.50, instead of $75.00.  However, every tick Crude Oil goes against the trader past $80.00 a barrel is going to count twice a much, eating up available capital a double the rate.  To make matters worse, markets that are trending in one direction, tend to continue to trend in that direction.

Not only did the trader cut crude oil to $ 75, but he also doubled the price back to $ 80. The losses are now accumulating exponentially if he continues to add to the losing position. In addition, he has now doubled his leverage in bad trading. Meanwhile, if the trader stopped at $ 1 or $ 2 a barrel of crude oil, he would have taken his loss and finished trading. When he is in a losing trade he can make big losses and let go of other opportunities, admit what he did wrong and move on to the next opportunity.

Admit about wrong if you can’t be wrong, you’ll never be right about the markets

It is OK to be wrong.  Actually, it is great to be wrong.  Why? Because if you can’t be wrong, you’ll never be right about the markets.  Trading is about taking risks and managing risk. The trader, who can get out of a situation that goes against him in advance, gives up the change to get bigger success at the next opportunity.

Negative mindset forms losses

Therefore, adding a loss level is equivalent to opening a new business immediately following a series of losses, which is a recipe for disaster.

However, there are ways to measure openness to achieve higher profits. But there is no way to add to the losing position.

Trade on Positive Positioning

Benefits of adding into positive positioning

• You aren’t adding to a position while in a negative mindset. This allows you to properly evaluate the market so you can be strategic about adding new positions. With positive energy on your side, you can operate based on logic rather than fear, thus increasing your odds of success.
• You are waiting for the market to confirm your trade idea. When you average down, you are increasing your risk without first having confirmation from the market. By waiting for the market to first move in the intended direction, the marketis giving you a reason to add to your position.
• You aren’t increasing your risk. When you average down, you are taking on additional risk due to the fact that you aren’t able to reposition your stop loss. However when you wait for the market to move in the intended direction before adding to a position, you give yourself an opportunity to minimize risk by moving your stop loss to a more favorable position as the market moves in your favor.

Conclusion

The advice to never add to a losing position cannot be overstated. It is far and away one of the most damaging mistakes a Forex trader can make, but it’s also one of the easiest to correct. Will the average ever play in your favor? Of course, you can occasionally make a profit if you buy or sell a currency pair blindly. But the detrimental effects of adding lost positions to continuing trading outweigh the positive impact it can have.

On the other hand, adding a winning position through pyramiding is the best way to increase your profitability. Keep in mind that the number one rule when building a pyramid is, always, always, not adding a losing position.