Averaging Down

In the stock market, every price shift presents an opportunity, whether during a bull or bear market. Investors can capitalize on short-term share price fluctuations to lower their average investment costs, reduce losses, or potentially achieve greater profits than initially anticipated.

Table of Contents

What Does Average Down Mean?
Example of Averaging Down
When to Average Down as an Investment Strategy?
Pros and Cons of Averaging Down
Frequently Asked Questions

What Does Average Down Mean?

Averaging down is a strategy where investors purchase additional assets, like stocks, when prices fall, lowering their overall cost per share. This approach is like dollar-cost averaging, as it reduces the breakeven point. However, acquiring more shares at a lower price increases the investor’s exposure to risk since they hold a larger position.

If the stock price moves up after you have purchased the additional shares, your profit will increase as your average price has been lowered. But your original loss will widen if the share price goes down further.

Example of Averaging Down

Suppose an investor holds ten shares of Company XYZ, whose share price has gone down from US$50/share to US$45/share. If he sells his shares, his loss is US$5/share.

However, he believes that the market is unduly pessimistic about the company and that the share price will recover eventually. He snapped up ten more shares at US$45/share.

His paper loss = 50 – {(10*50 + 10*45) / 20} = 50 – 47.5 = US$2.50/share.

This is lower than his original potential loss of US$5/share.

When to Average Down as an Investment Strategy?

If you are a long-term investor and your original reason for liking and buying a stock still applies, it makes sense to accumulate its shares.

However, if something fundamental has changed about that company, such as a loss of market share to competitors or slowing sales growth, averaging down may not be a good idea as you could be throwing good money after bad.

Pros and Cons of Averaging Down

The primary advantage of averaging down is that it lowers your average investment cost. Acquiring more shares as prices drop decreases your cost per share. If the market rebounds and the stock price rises, you could see greater profits from holding a larger number of shares at a lower average price.

The primary drawback of averaging down is the heightened risk. As you increase your investment by buying more shares at lower prices, you also raise your potential losses. If the stock price continues to drop, your losses could exceed those from your initial investment.

Frequently Asked Questions

How do I calculate my average cost price after averaging down?

Average cost price = (Sum of prices of all my shares) / (Total number of shares)

Lump-sum investing versus average down: which is better?

In lump-sum investing, you invest a big sum of money into an asset. You gain exposure to that asset immediately. When markets are on an uptrend, putting your money to work right away helps you take full advantage of price growth.

In averaging down, you buy more stocks when prices are falling. Averaging down may be appropriate when you want to minimise the downside risk from a huge investment or take advantage of the market’s natural volatility to lower your average price.

Does averaging down mean I can’t “buy low and sell high”?

No, the whole idea behind averaging down is to buy low and sell high i.e. buy more shares in a bearish market at a low price and sell them in a bullish market at a higher price.

When Is Averaging Down a Good Idea?

An averaging down strategy is most effective when investors are confident in their investment’s long-term success. By buying during market dips, they can build a position at increasingly favorable prices, enhancing the potential for higher profits.

How do you average down properly?

Averaging down is an investment strategy where an investor buys more shares of a stock they already own after its price declines. This additional purchase lowers the overall average price per share. This approach contrasts with averaging up, where shares are bought at higher prices.