Averaging down is an investment strategy that involves buying additional contracts of an asset when the price drops. This way, the investor increases the size of their position at discounted prices. The averaging down strategy is highly debated among traders and investors because it can either lead to huge losses or great returns. Nevertheless, averaging down is often used and favored by long-term investors and contrarian traders. With careful/proper risk management, averaging down can cover losses and magnify the returns when an asset rebounds. However, the main concern for a trader is that it can be hard to identify the difference between a pullback or the start of a new trend.
HOW DOES IT WORK
Averaging down is a method to lower the average price at which the investor buys an asset. A lower average price can help investors come back to break even quicker and, if the price continues to rise, get an even bigger upside and thus increase the total profit from the trade. For example, We buy 100 shares at $60 per share, a total investment of $6000, and the asset drops to $40 per share; in order to come back to break even, the price has to go up 50%. (($60/$40) – 1)*100 = 50%.
The power of Averaging down comes into play if the investor buys additional shares at a lower price, like another 100 shares at $40 per share; now the total investment is ($6000+$4000 = $10000). The average price for the investment is now $50 (($60 x 100) + ($40 x 100))/200; in order to get back to break-even, the price has to rise 25% ($50/$40)-1)*100 = 25%, and if the price continues up to $60 per share, the investor can secure a profit at 16%. So by averaging down, investors and traders can cover the losses easier and potentially have more profit to secure at the end.
THE AVERAGE DOWN TRADINGVIEW TOOL
This script/indicator/trading tool helps traders and investors to get the average price of their position. The tool works for Long and Short and displays the entry price, average price, and PnL in points.
HOW TO USE
- Use the tool to calculate the average price of your long or short position in any market and timeframe.
- Get the current PnL for the investment and keep track of your entry prices.
APPLY TO CHART
When you apply the tool on the chart, you have to select five entry points, and within the setting panel, you can choose how many of these five entry points are active and how many contracts each entry has. Then, the tool will display your average price based on the entries and the number of contracts used at each price level.
Set your entries and the number of contracts at each price level. The indicator will then display all your short entries and at what price you will break even.