Is Averaging Down a Good Idea as Investment Strategy?

Averaging down is an investment strategy wherein the aim is to reduce the average cost per share of a company’s stock you have bought. Let’s understand it with a simple example. Let’s say the price of one share of XYZ Corporation is USD 60.  Maria bought 100 shares of this company for a total of USD 6000. Therefore the average cost that Maria paid per share turns out to be (6000 / 100) USD 60.

Assume that, due to a stock market crash, the share price of XYZ Corporation comes down to USD 50. Instead of panicking, Maria buys 100 more shares at this reduced price. Now, Maria has 200 shares for which she has invested a total of (6000 + 5000) USD 11,000. So, what is her average cost per share now? It is (11,000 / 200) USD 55. This is a good 5 dollars less than the average cost she got after her initial investment.

How is Averaging Down Done?

Here what did Maria do? She simply took advantage of a market shake-down. She bought another lot of shares at a cheaper price. Thus she reduced average cost per share by increasing her overall investment in the company. Averaging down is done with the hope that the stock you believe in will rise and give you higher profit. If you want to go for this strategy, it requires two things: One is solid faith in the stock and the other is more money to pump-in. If you have both, you can go ahead and increase your investment in the stock when others are selling (i.e. price is coming down).

Learn what is averaging up

Is Averaging Down a Good Idea?

Well, it depends on your philosophy. In general, averaging down can be a good idea if you have invested in a fundamentally strong stock. Such stocks may see temporary falls when market reacts to various influences. Such temporary hiccups notwithstanding, fundamentally strong stock tend to give good returns over a  longer period of time. Averaging down involves increasing investment — i.e. putting more of your hard-earned money into the market. Of course, you should do it only when you have great faith in that particular stock.

If you believe in the future of a stock, you may go ahead and take advantage of market fluctuations / crashes and increase your investment in that stock.

Benefit of Averaging Down

The simple formula of profit is buy at lower price, sell at higher price. The averaging down strategy takes care of the buy at lower price part of this rule. This strategy brings down the average cost and thus provides you with a lower breakout point towards the profit. Also, because you will have invested more money, your gain will also be more as the stock rises past your average cost.

Averaging Down and Associated Risk

A common problem is that a large number of investors average down the stock price only on the basis of hope that the stock will show uptrend and revive. See, only hope is not good enough in stock market. Hope must be accompanied by good analysis and research, you should go for averaging down only for the stocks wherein you have faith by the virtue of your research. Merely hoping, without any underlying logical research, may heap loses on you. Hope sans research may lure you to invest more in a losing cause. So, beware!