Why you should prefer to average up than average down?
Averaging or buying more is a typical action most traders and investors undertake when they trade or invest. Averaging down means buying more when the stock is going down contrary to expectations and averaging up means buying more when the stock is going up in the desire direction. Let us understand this with relevant examples.
Suresh bought shares of XYZ company at Rs 100 with a view that the price will touch Rs 125 in a month. However, soon after his purchase the stock tumbled to Rs 98, so he added more to his kitty. The stock further went down to Rs 95 and he bought more. Here he is said to be averaging down.
Ramesh bought shares of PQR company at Rs 100 with a view that the price will touch Rs 130 in a month. Soon the stock hit Rs 105 mark and he bought more and he further added to his position when the stock crossed Rs 107 mark. He is averaging up in his trade, says the market jargon.
The logic offered by a trader who is averaging down is that the average cost of the holding goes down and the trader makes big profit when the price gains. However, an attempt to average down can be a loser's game. When the stock price moves contrary to expectation, the trader may have got his analysis wrong. A call that has gone wrong can further wipe out trader's capital. The hope that the price will rebound make many traders add to their losing position which further aggravates overall losses if the price does not respond favourably.
Hence market wisdom says that one should further add to the winning positions. If a trader is making money in a trade, it makes sense to add more to that position. If he has bought a share and the share is in bullish phase, he should ideally buy more than feeding capital to a loss making position.
The old adage of cut your losses and let your profits run is to be kept in mind when one trades.
Averaging or buying more is a typical action most traders and investors undertake when they trade or invest. Averaging down means buying more when the stock is going down contrary to expectations and averaging up means buying more when the stock is going up in the desire direction. Let us understand this with relevant examples.
Suresh bought shares of XYZ company at Rs 100 with a view that the price will touch Rs 125 in a month. However, soon after his purchase the stock tumbled to Rs 98, so he added more to his kitty. The stock further went down to Rs 95 and he bought more. Here he is said to be averaging down.
Ramesh bought shares of PQR company at Rs 100 with a view that the price will touch Rs 130 in a month. Soon the stock hit Rs 105 mark and he bought more and he further added to his position when the stock crossed Rs 107 mark. He is averaging up in his trade, says the market jargon.
The logic offered by a trader who is averaging down is that the average cost of the holding goes down and the trader makes big profit when the price gains. However, an attempt to average down can be a loser's game. When the stock price moves contrary to expectation, the trader may have got his analysis wrong. A call that has gone wrong can further wipe out trader's capital. The hope that the price will rebound make many traders add to their losing position which further aggravates overall losses if the price does not respond favourably.
Hence market wisdom says that one should further add to the winning positions. If a trader is making money in a trade, it makes sense to add more to that position. If he has bought a share and the share is in bullish phase, he should ideally buy more than feeding capital to a loss making position.
The old adage of cut your losses and let your profits run is to be kept in mind when one trades.
Happy Investing
Source:Moneycontrol.com
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