Dollar Cost Averaging
In the realm of long-term investing, dollar cost averaging (DCA) is a widely accepted practice for growing and protecting wealth. Under the guiding tenets of DCA, an investor purchases securities at regular intervals, the most common of which are monthly and yearly. Individual stocks, mutual funds, or exchange-traded funds (ETFs) are frequently targeted instruments.
As the name “dollar cost averaging” implies, the primary goal of the strategy is to “average in” to a security at a median price. This is accomplished over time, with many entry points contributing to a net long (or possibly short) position. Essentially, when a trader practices DCA, the peaks and valleys of a security’s pricing are mitigated; the only value that matters is the net long (or short) of the aggregate position.
DCA offers investors an opportunity to take a position in a market or security while limiting risk and guesswork. All a trader really has to do is determine how much money to allocate, a schedule for order execution, and a desired asset. Of course, as with all things trading, downsides exist. Missing out on trends and adding to an existing negative position are two of the most glaring.
Losers Average Losers
In many circles, Rule #1 of active trading is to “never add to a loser.” Countless financial experts are on record touting this as being the golden rule, akin to “knowing when to fold ‘em” in poker. From Jesse Livermore in the early days of Wall Street to Paul Tudor Jones in the 1980s, conventional wisdom has always deemed adding to a losing position as being a no-no, a precursor to gambler’s ruin.
Any trades are educational examples only. They do not include commissions and fees.
Rule #1 often runs contradictory to DCA methodology. If an investor buys a stock at $40 this month, after buying at $50 last month, isn’t that a flagrant investing foul? The answer is surprisingly “no.” If executed within the framework of “buy and hold” advanced trading strategies, then the investment horizon is long enough to mitigate risks associated with the negative entry. Unless you’re snatching up shares of a doomed stock (remember Enron?), the cheaper purchases will largely “average out” the more expensive ones.
However, executing a DCA strategy in futures is a bit different. Due to the fact that a futures contract has an expiration date, longer-term investment strategies are not tenable the way that they are in stocks. Eventually, the contract will come off the board, ensuring that a profit or loss on your position will be booked. It’s because of this characteristic that adding to a losing position in futures is inherently riskier than it is in stocks ― a futures contract is a perishable item while, in most cases, stocks are not.
So, the question remains: Are DCA advanced trading strategies ideal for futures? The correct answer differs — and is largely dependent upon — your resources, goals, and strategy. If executed within the framework of a comprehensive plan, it may indeed magnify returns while keeping risk in check. However, if you’re going to pile leverage on to a negative position in the futures markets, you better be aware of the following factors:
- Timeframe: What is the trade’s horizon? Is contract expiry or end-of-day approaching?
- Fundamentals: Economic data releases, breaking news reports, and comments from financial heavyweights can spike volatility. Increasing exposure on an already negative position during these times can be catastrophic.
- Concrete pain threshold: It’s a fact that a considerable percentage of successful trades go negative before eventually becoming winners. If you’re going to buck short-term price action and “average in” to a position, knowing the exact point when the trade has failed is a necessity. When it’s over, get out!
The vast majority of trading literature recommends to never add to a negative position. In the words of Paul Tudor Jones “losers average losers.” While it’s tough to argue with the logic (and success) of investment legends, given the proper planning, advanced trading strategies based on averaging-in can be viable ways of trading futures.
Develop Your Own Advanced Trading Strategies
Successful futures trading is a product of desire, dedication, and humility. Being able to admit you’re wrong, take a loss, and move on to the next trade can save you countless dollars over the long run. Nonetheless, advanced trading strategies involving adding to losers or DCA may be worth looking at, assuming you always keep risk in check.
For more information on the topics of market game-planning and strategy development, check out our Futures & Options Strategy Guide below. Whether you’re looking for new trading opportunities or a capital-efficient way to manage portfolio risk, futures and options offer a wide array of products to accomplish either objective.
