How many times have you had a position to go against you? You planned the trade correctly, but soon after you bought your initial position, you discovered that the price you paid was higher than what it was now worth. The first trade was a loser compared to the market price. What could you do with this losing trade? You could sell it out and look to buy something else, or you could buy a few more shares or contracts at the new lower price. Which is the better solution to your dilemma? In most cases, Most people, however, would buy more at lower prices.
They would average their losses on the way down if they are buying, or average their losses on the way up if they are shorting. There's an old saying that if it looked good at a higher price, it looks a lot better at a bargain price. Traders determine whether they will average or not by looking at what they are trading: stocks, options, or futures.
Let's look at each of these trading vehicles in terms of averaging losses. When dealing with stocks, averaging losses at lower prices can often work, depending on the viability of the company you are averaging your position in. This means that the company you are buying mustn't go bankrupt or in any way destroy your ownership interest. If there is even a slight chance that your stock will become worthless through bankruptcy, you will never get back your investment. If another company buys or merges with your company, the acquiring company either converts your ownership to a portion of the new company or pays you cash.
You will have to average your losses in the newly formed company or else you will be cashed out and will realize a loss on your holdings in the original company. Investors who average their losses will do whatever they can to avoid this. After incurring forced losses due to mergers or buyouts, these investors will forsake their original plan to average their losses and will take the tendered cash to buy stock in the new company or to invest in other companies.
This approach can work at times, When they trade in commodities, most investors and speculators rarely consider that they are playing these markets at a fraction of the total value of the contracts. Unfortunately, when it's time to take delivery of these commodities, most undercapitalized players, up against the trading giants, will not be able to ante up. In each of the three cases, stocks, options, or futures, the initial consideration in averaging losses was whether or not the total investment or speculation could disappear to zero value.
With stocks, this was possible only if the company went bankrupt. With options, you could average your losses only. Even with the zero-value consideration in mind, it would be rather risky. Though commodities always have intrinsic worth, it is extremely unlikely that the traders who speculate and try to average their losses would have enough capital to take physical delivery of the commodities at expiration. Few players have the capital strength to take physical delivery of commodities. Those who do can make some interesting plays. Free stock tips