Forex Investment and Currency Trading

Depending on the trade setup, you may be entirely justified in averaging into a position. In fact, with some trade opportunities, you’ll be hoping to have the chance to average into the position at better rates, because if the trade setup is correct, you’ll want to have on as large a position as possible.

Even though we’re suggesting that certain trade opportunities warrant averaging into a position, we want to stress that you still need to identify the ultimate stop-loss exit point in every trade setup. In other words, you can average into a position as much as you want up to a certain point, but after that the trade setup is invalidated, and you need to exit the position.

The trade setups are those where a reversal is anticipated. We may get signals of an impending reversal from daily candlestick patterns, such as hammer / hanging man, double doji, or a tweezers top / bottom. We may begin to suspect a reversal after a significant intraday spike reversal / rejection from key technical levels. The market may also be nearing important long-term trend-line support or resistance that suggests a medium-term bottom or top is close by.

What all these setups have in common is a price difference between current market levels and the ideal entry point based on the setup. For example, major daily trend-line resistance dating back six months may lie above in EUR/USD 1.2960/70. Current market levels are well below at 1.2890, and there has been a spike rejection from an intraday test to 1.2930/35. Adding up these observations, we may justifiably conclude that the current market price is just below an area of major resistance, suggesting a short position as the overall way to proceed.

But we have no accurate way of predicting how much higher the market might trade, or even if it will, before the anticipated reversal lower takes place. The market could start moving directly lower from the current levels. It could retest the spike highs seen earlier in the day, or it could make it all the way to test the key trend-line resistance before stalling. So where should we look to get short?

The answer is in that zone of resistance we’ve just identified between current market levels and the daily trend-line resistance above. This is where it makes sense for us to average into a trade to exploit the trade setup.

We may not know how much higher the market will go, but we may be prepared to short a portion of the overall position at current market levels, in case the top has already been seen and prices move directly lower. We may also be prepared to sell remaining portion(s) of the position at successively higher levels, if the market allows it. We’ll save our last portion of the position for the trend-line resistance level in case it’s reached.

When considering where to leave your limit-entry orders to average into a trade, be aware of what your final average rate and your stop-loss level multiplied by the total position size will give you the total amount you’re risking on the trade.

Although we may not have any 100 percent accurate gauges to tell us how much higher the market is likely to trade, we can use short-term momentum studies – such as stochastic models, the Relative Strength Index (RSI), or Moving Average Convergence / Divergence (MACD) – to make an educated guess as to how much more upside potential there may be.

If hourly momentum studies have already topped out and crossed over to the downside, the upside potential is likely to be more limited. This may argue for being more aggressive in establishing a short position, such as making the initial sale at current market levels and placing any additional limit orders to sell above at closer levels. But if hourly momentum studies are still moving higher, we can reasonably wait and look to sell at relatively higher levels using limit sell orders.

Averaging into a reversal setup requires that you’re able to buy / sell multiple lots over a relatively large zone of prices, sometimes as much as 100 pips or more. Make sure that you have sufficient margin resources available before you start averaging into your overall position.

Depending on the size of the buy / sell zone and your available margin balance, you may have to space your limit-entry orders farther apart or trade fewer lots overall. Also, if you’re looking for a medium-term reversal, make sure your take-profit objectives reflect the relatively larger price move you’re expecting.

It’s always a trade-off between being in the right position to catch the move and getting in at the best price possible. It’s quite frustrating to identify a potentially significant market reversal, leave limit-entry orders, but then see the reversal take place without any of your orders being filled. Averaging into the position is one way to make sure you’re on board for at least some of the move.

If the setup works out, you’ll have taken advantage of any favorable price moves the market has made, resulting in a better coverage rate on your position. If the setup fails, averaging into the position at successively better rates will cost less in the end than entering the whole position at the current market level.