Double Down Trading Strategy — Concept and Backtest Findings

A trader in a losing stock position has only a few options: they can close the trade at a loss and look for opportunities elsewhere; they can hold the losing position for a while and hope that the price will turn around and get to their entry price, which may take a long time if it happens at all; or they could decide to use the double-down strategy. What does the double down trading strategy entail?

The double-down strategy is a stock trading strategy that entails adding another position to a losing trade, with the hope that the reversal will help you recover your losses. It involves doubling your position when the stock price falls in order to improve your average order entry price.

In this article, we show in backtests when a double down trading strategy works or not works. Let’s go a bit deeper.

What is a double-down trading strategy?

The double-down strategy is a stock trading strategy that entails adding another position to a losing trade, with the hope that there will be a reversal to help recover the losses. It involves doubling your position when the stock price falls in order to improve your average order entry price.

In the case of a losing long position, it means buying the same number of shares as the initial position as the market goes against you with the hope that the price would rise again so you can break even if the price recovers just half the suffered decline.

To understand the double-down strategy, we will use an example:

Let’s say you bought 100 shares of Amazon stock at $136 per share and then the stock price dropped by $36 to $100 per share. You may consider the loss unacceptable and refuse to close your position at a loss.

In that case, you can hold and hope that it recovers, which may take a long time. If you want to break even as early as possible, you may choose a double down strategy by buying another 100 shares of Amazon. If the stock reverses and appreciates by $18 (half of the decline), you will already be at breakeven because the loss on the initial 100 shares has reduced to $18 per share while at the same time, the second 100 shares have gained a profit of $18 per share. This is the essence of a double down trading strategy.

However, it doesn’t always work like that — the stock can keep declining after you buy the second position. With the double-down strategy, you sometimes throw money after a bad trade in hopes that the stock will perform well.

Is the double down trading strategy rational?

The “problem” with a double down trading strategy is that you focus on the price and not the odds of succeeding. In trading and investing, you need to focus on the process and the odds for success. The market doesn’t care about your average price and goes wherever it likes. Thus, the average price is often a mental bias, some kind of anchoring. Is a double down strategy part of your overall strategy? Always keep this in mind!