Having seen many documentaries of professional (directional)
traders talking about adding to winning positions, I had a little brainstorm of
why this helps with profitability of trades. Here’re some reasons I’ve come up.
So the basic idea is to only add to a winning position, and
reduce position size as it moves negatively. We can already see how this replicates
option delta, where
the trade becomes essentially long Gamma, without
risks around Vega,
Theta, and other
Greek uncertainties.
1)
It gives a convex
payoff; it creates monster winning trades with respect to average losing
trade size. (Convexity
vs. Concavity)
2)
Having a convex payoff requires much lower
win-rate for a trading strategy to be net profitable i.e. maintain a positive
EV.
3)
The trade would have a significantly reduced
probability of taking relatively large losses. We’ve all heard stories of
people blowing out from short Gamma trades, such as adding to losing positions,
selling naked options.
4)
Counter-Intuitive, and we know going against the
crowd is usually a GOOD thing in this industry.
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