Catching a falling knife ideas
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Today I have been messing around with averaging down or catching a falling knife as some like to call it. Some will suck in air through their teeth and say don’t touch it – but it has its place in trading. Warren Buffet wouldn’t think twice about averaging down. Buy it while it is cheap is his theory but then he only buys because he has done his research and knows the company will come good again. So if you are buying something good and you are confident that it is only a short down turn then averaging down can work very well.
So I have been messing around with some ideas and the best I have come up with so far is to increase the amount a market has to drop between each entry and increase the position size at each entry.
The (long trades only) code I have to achieve this is this:
12345m = 1If onmarket and close < tradeprice * (1 - ((countofposition * m) / 100)) thenBuy PositionSize * (1 + (countofposition * m)) contract at marketendifm can be increased to increase the distance and sizing accordingly but 1 seems to work ok on the DJI
…and this is how it would have coped during the big crash at the beginning of 2016 on the DJI daily:
As you can see the distance between each entry increases and the position size also increases depending how far we are from the last trade all calculated from count of position. Yes the draw down was pretty big but it at least came out as a winning trade at a price well below the first entry point and this is probably the most extreme example of the last few years.
I’d be very interested in anyone else’s ideas on averaging down techniques…..
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Here is another image. This time it is the crash of 2008 on the DJI daily. As can be seen the first entry could not have been timed much worse but the averaging down with increasing distance between trades and increasing position size saved the day just as we thought that all the previously won profits were wiped out. In the end we exited 1378 pips lower than we first bought at with our previous profits intact and an additional £351 profit on top. An exciting ten days!
….and here is the exact same strategy for the exact same period in 2008 but on the FTSE100. Once again we exited at a lower price than the first entry and with profit. We exited 611 pips lower than the first entry after 10 days with 539 pips profit. Once again exciting days but definitely worth averaging down and living with the draw down.
You can already try partial closure in backtests.
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Wilko – Yes if you start with a lot of capital that you are happy to lose based on the probability that you probably are very unlikely to lose it all then making a pretty much guaranteed small profit is very, very easy using averaging down.
At the moment I am currently in a life position where if I had that sort of capital then I would probably just start spending it rather than risking it and hope that it ran out just before I died. You can’t take it with you!
Recently IG (and other brokers) have reduced the minimum position size to about 1/5th on most instruments in response to the 5 times increase in most margin rates for retail traders caused by the new ESMA rules. This reduction in minimum position size has the benefit that we can now use a smaller starting capital to maybe make a few hundred pips a year from an averaging down strategy without worrying that we are risking too much. In fact it is worth the risk especially if we add a fuse filter to our averaging down strategies to ensure that we don’t risk the whole bank. 50% of our capital must just be there to avoid margin calls and we should never actually place it at risk on the markets!
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I suggest to use another instrument for this trading strategy. Options for example since it is a safer way to keep a lid on the drawdowns.
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….and here is the exact same strategy for the exact same period in 2008 but on the FTSE100. Once again we exited at a lower price than the first entry and with profit. We exited 611 pips lower than the first entry after 10 days with 539 pips profit. Once again exciting days but definitely worth averaging down and living with the draw down.
Whilst this Oct 2008 buying the knife would have worked and looks doable in hindsite the reality of buying that knife not so easy within a few weeks of Lehmans collapse . Probably the most fearful couple months marketwise in many generations . Most wouldnt have had capital at that stage . Interesting concept and worth investigating , maybe relative lower volatility times wouldnt be so hard on the heart 😉 . We are talking about a period where 10period daily ATR was between 4 and 8% for around 10 weeks on US indice
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