Is Averaging Up a Good Idea as Investment Strategy?

Recently we discussed averaging down strategy for making investment in a stock that you already own. Averaging down appears to be a straightforward and intuitive idea. However, a lot of investors go for the strategy exactly opposite of it; i.e. averaging up! Most of the people question the usefulness of averaging up because it sounds counterintuitive. Let’s dive into the details and find out if averaging up can really be a good investment strategy.

What is Averaging Up in Stock Market?

Averaging up refers to an approach in which the investor keeps on buying a certain stock even as the stock price goes up. As a result, the average cost per share of owning that stock also goes up. For example, let’s say last year David purchased 100 shares of PQR LLP at an average price of USD 20 per share. Owing to the good business and profits, this year, the share price of this stock goes up to USD 40 apiece. Now, the investors who believe in averaging down will say, “Ah! the stock is really good! But the price has become too high, I will buy more of it when the price will come down to around USD 20.”

However, our smart fella David believes in averaging up. He goes ahead and buy 100 shares more at a price of USD 40 per share. Consequently, for David, the average cost of owning this stock goes up and settles at (6000 / 200) USD 30.

But why did David do something like that? Don’t you see the stock market’s mantra of “buy at lower price, sell at higher” goes for a toss here?

Rationale Behind Averaging Up

The logic behind averaging up strategy is simple and very interesting indeed! Investors do averaging up when they have strong confidence in a particular stock. The whole idea is: why would you invest in a stock in which you do not have confidence to begin with? Also, wherever you have the confidence then the price simply should not matter!

This is an excellent viewpoint — something which most of the investors actually tend to miss! If you want to make profit in the stock market, merely buying at a lower price is not important — what is actually much more important it what you are buying. Irrespective of which strategy you employ, investing in low quality stocks will eventually be a loss making enterprise.

Averaging Up and Averaging Down: Which is Better?

Both these approaches should be applied. However, remember, quality of the stock is paramount — not the price. You must do research and analysis and select the stocks you strongly believe in. After that, just keep on buying the stock whenever you have funds to invest. You may wait a little to see if the price comes down so that you can buy at a lower price (and probably average down). But do not wait forever and pay a much higher price when you eventually decide to buy way deep into the future. If you have selected good stocks, keep adding shares to your portfolio at regular intervals.

Not too often, but even the good companies sometimes turn into bad businesses. Thus, it is not like you have bought a great stock and then you can forget about it. You must always keep an eye on the developments related to the company. If the price is going down, you must try and find out why it is going down. Similarly, you should also know why the price is going up.

Information is power in stock market. It helps you make better decisions.