Averaging losses and over-leveraging are the two common pitfalls in financial trading. Averaging losses, in essence, transforms and degrades a principle-based trading endeavor into an emotion-based gambling thing. Over-leveraging manifests itself in traders taking unduly excessive risk by heavy borrowing and hence a rising likelihood of going under.
Both are dangerous, unsound and they are often inextricably intertwined. Traders who average losses tend to over-leverage when losses pile up, while traders who over-leverage are prone to averaging losses when markets move against them. A perfect storm is in the making when the two are working in tandem — losses rapidly snowball. That’s precisely why a wise trader will never average losses, never over-leverage.
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