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The Best Trading Strategy

How Important Is Trade Entry?

Just before I teach you the best trading strategy I’m going to share with you the worst trading strategy of all time. There are a million and one strategies that can be applied to all aspects of trading. I’m going to share with you what I consider to be one of the worst if you consider yourself as a trader, as part of the trading rules.

You must be wondering why I would want to spend time illustrating the worst trading strategy around. It’s simple. By showing you how it works (or, in this case, doesn’t work), I hope to show you clearly what not to do while encouraging you to do the exact opposite.

To Average Down is to throw your money right down the drain and most possibly the worst trading strategy of all time

Too bad, for the beginner, averaging down seems quite logical but it is fundamentally flawed. Many people have become stuck in its claws and have lost substantial amounts of money because of its apparent logic. Do not be one of them!

Averaging down is the process of buying more and more units of a falling stock in a desperate attempt to recoup your losses and reduce your effective buy price. When you look at it closely, it’s really just throwing good money after bad.

The thinking behind this type of strategy is denial. People believe they can reduce their initial entry price by continuing to buy more as the stock’s price falls away. It’s the modus operandi of distressed traders, traders in a panic. As a strategy it is hardly ever effective. To make matters worst, you’ll magnify your losses if the stock keeps dropping.

One must understand, just because it’s cheap now does not mean it’s not going to get any cheaper.

Let’s look how this strategy works in action. Let’s say you bought 2,000 shares at $50. Step one, don’t have an initial stop in place. Step two, watch the price fall to $40 and do nothing. Here comes the stupidity of this strategy – step three, buy another 2,000 units at $40 to lower the average cost per unit already purchased. Your average cost per unit would now be $45.

It gets worse. Price may fall even further and the novice trader will again buy more units to reduce the effective average cost per unit. The effect is such that he buys more and more into a stock that’s losing his money.

Now, try to imagine this strategy being applied to a portfolio of stocks. What ends up happening is that all your trading capital is allocated to the worse performing stocks in the portfolio. The result is, at best, a disastrous underperformance versus the market.

If a trader averages down and is using margin, then you can only imagine this would magnify those losses even further. The effects can be devastating. So, hear me now: never average down.

The best trading strategy works the exact opposite. To maximise profits you should put your money into compounding successful stocks. That’s trading risk management.

Take to heart some lessons from admired trader Marty Schwartz and take heed of his advice: “I’m more concerned about controlling the downside. Learn to take the losses. The most important thing about making money is not to let your losses get out of hand.” The best trading strategy recognizes that if you control the downside with a comprehensive money management then profits will be yours in the long run.

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