What is averaging down?
Averaging down is when additional shares which have dropped in price are purchased in order to reduce the average cost.
For example, you buy 500 shares at £10 per share, but the stock drops to £6. You then buy another 500 shares at £6 per share, which lowers the average price to £8 a share.
Where have you heard about averaging down?
The investment world is littered with the wreckage of traders and private investors who threw good money after bad because they kept adding to stock positions that didn’t go back up. But there are still many exponents of averaging down who see it as an opportunity to bag a bargain.
What you need to know about averaging down..
Averaging down can indeed sometimes be a good strategy to employ, especially if you’re planning to hold on to the stock for a long period of time. Averaging down can be a useful tool in ensuring that the securities are sold at the right time as it can impact the breakeven point of the shares. But it’s not a decision to be taken lightly as you could be waiting for a rebound that never happens. In many circumstances it’s simply better to cut your losses rather than buy more shares.
Averaging up is the opposite of averaging down, as it brings the average price paid per share up following the purchase of additional shares at a higher price than the original share.
Loss aversion plays a part in the decision making process when considering averaging up or down, so it pays to do your homework on the company you’re investing in, so you have a good insight into whether the drop in the stock’s price is temporary or a sign of trouble.