Pros & Cons of Dollar cost averaging | how much does smart dollar cost

Do you want to know more about one of the most common trading mistakes? Watch our latest video about pros and cons of dollar cost averaging and learn to avoid a fatal trading mistake.

Pros and Cons of Dollar cost averaging explained

Unfortunately, over the last several years, Wall Street has made a living convincing traders to “dollar cost average.” Dollar cost averaging simply means to add to a losing position. The idea, in theory at least, is that when the market turns around you will have a larger position on the way back up, meaning that you regain your losses quicker, and then eventually have even larger profits. While this is a nice thought, when it doesn’t work it typically leads to an absolute disaster.

Wall Street has told investors that dollar cost averaging is the way to go. However, what makes that scenario different is that it is based upon a much longer timeframe. Typically, somebody who is dealing with a stockbroker is thinking along the lines of retirement, and that quite often is 40 years away. Because of that, the market should eventually turn around and therefore dollar cost averaging makes sense. But with a trader, it’s going to be completely different. This will be especially true if you are trading a leveraged instrument such as Forex or the futures market. This is because leverage works both ways, both for and against you. If the market is moving against you, the losses can pilot just as quickly as the gains can when you are correct.

Looking at the S&P 500 CFD market, you can see that the futures contract was trading at 1560 back in June 2007. This was the absolute height of the market before the financial crash. As you can see, dollar cost averaging on the way down would have absolutely bankrupted you. The market fell all the way down to the 666 level, and adding to your long position on the way down would have been an absolute unmitigated disaster. Because of this, stop losses are essential, and once they are hit you must simply walk away. There is no excuse to hang onto a losing position once you are proven incorrect.