Trading Strategy: Average Down

Average Down is the process of buying additional shares of a stock if the price went down than when you originally purchased it. It lowers the average price of the stock you bought but it increases your exposure to the stock.


How it Works?
Le us take an example the PHES stock. On May 23, you bought 10,000 shares of PHES stock at a price of .74. After five days, the price went down to .64 and you bought 10,000 shares again. Below is the summary of your buying transactions.

Date	Price	# of shares	Amount
23-May	0.74	10,000	7,400.00
31-May	0.64	10,000	6,400.00
	Total	20,000	13,800.00

What did you noticed? The 10,000 shares you bought before at 7,400 pesos is worth 6,400 pesos now because the stock price went down. So you bought another 10,000 shares on May 31 so that you can lower your average price.


In order to compute the Average Price, just divide the total amount paid against the total # of shares you bought. In your case, the Average Price is .69.

Total Amount Paid	13,800.00
	÷
# of shares bought	20,000
Average Price	0.69

If the stock price went up to .69, you are break-even already . Whereas if you did not average down (meaning you did not purchase additional shares on May 31 at 10,000), you are still in red because you bought the stock at .74 per share.


Holding a Down Stock?

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I know a few people who are doing average down. Their reason is that they are in a position to profit already if the price go back to their original price (.74) because their average price is now lower (.69) .  Or if they want to go out and sell the stock at break-even, they average down so that they can move out from the stock easily.


Personally though, average down works if you have identified a major support (see Support) in price and the fundamentals remain intact. If the PHES major support price is .63, you need to watch that price. If it holds and bounce back after a few trading days or weeks, then you can buy near that price, perhaps the stock is just under a correction mode. 


Fundamentals like growth prospects, sound business strategies, competent management, etc. shall form part of the reasons of why you must average down.


When Hoping is not Healthy

In stock market, you buy a stock because you saw something in that stock and you think that something will propel it to go higher whether it is based on technical or fundamental basis.


On a technical perspective, if you found that the major support (see Support) of PHES is .63, then you need to buy near that price. However, if the price go down to .62 in any single trading day, then it's time to sell even at a loss. Otherwise, you need to find another reason why you must keep the stock.

http://www.flickr.com/photos/27015396@N08/3512146240

Selling at a loss is the most difficult aspect in trading. Who wants to sell at a loss? Nobody, right? It sometimes ruins your entire day and affects your relationship with others. It is an unhealthy emotional stress because you are doing something against your natural desire to profit in the stock. It creates anxiety and loss of sleep. 


A lot of people average down to make up for a bad trading decision. The fundamentals became uncertain already and the technical looks bad and yet they still hang on to their stock. They are hoping that their battered stock will go up one day. Don't put good money after bad money. Losses after losses. Sometimes, you need to jump from a sinking ship and save your life. 


Friend, if there is no more reason to hold a stock, let it go. Charge it to experience. I know it is very difficult to sell a stock at a loss because I've been there before. I just rode the experience, let it go, inhaled deeply and move on. Lessons learned.