PYRAMID AVERAGING
Whenever we are caught on the wrong side of an open forex position, we either cut our losses or average down. The typical mindset is to average down to fight one "last-battle" and hope to get out at midpoint on the rebound.
Instead of just averaging 1:1, we should consider Pyramid Averaging. Like a pyramid, where the apex is small while the base is large, we add-on a larger exposure than the original one that we were caught with.
Example :
BUY 1 unit @ $5 and the price dropped to $3 (intended Stop Loss = $1)
- Average down by Buying 2 units @ $3
- Net Position = 3 units @ $ 3.66
- Place S/L @ $2.70
The net effect of the above is that we still lose $1 (absolute amount) but allow the market to move against us $2.30 before we to lose $1 !
By applying the pyramid averaging technique (1.5...2....3 times the initial position), we improved the odds of not being hit by "stray-bullets', yet still allow the market to go against us for $2.30!
What was described above, is a defensive play. We can also use Pyramid Averaging to build up our position in situations whereby we knew that a market low is within the proximity. At the same time, we are impatient and do not want to wait for the market levels. We can then Buy 1 unit @ the market and then place another order for 1.5 or 2 units at our ideal entry levels. This will improve the Buying average cost down 60% from where we got in.