Trillionaire Term of the Day - February 3, 2009 - Average Down

Average Down

Averaging down is an investing technique for bold investors who really have confidence in their stocks.  Averaging down is essentially the process of buying additional shares in a company at lower prices than you originally purchased.  By using this strategy and buying on weakness, the average price you paid for all your shares comes down. 

For example, if I bought 100 shares of Intel (INTC) at $20 per share, the average cost per share for me would be $20.  Let’s say after owning it for a couple of weeks, Intel’s share price drops to $15.  If I really believe that Intel’s share price will rebound, should I sell the stock at $15, or should I take advantage of the drop in share price?  If I employed the averaging down technique, I would buy 100 more shares of Intel at $15.  As a result of my new purchase, my average cost per share of Intel would be $17.50 (100 shares X $20 + 100 X $15 all divided by 200).  Now, instead of Intel having to come back up to $20 for me to break even, I just need the stock to reach $17.50.

Is averaging down a good or bad strategy? Well, if you average down and buy more shares as the stock price goes lower, you will increase your profits if the stock makes a rebound.  You will increase your profits because, not only do you have more shares of the company, but your new average cost per share is lower than your original cost per share.  So, if you really trust the company that you are investing in and believe that its stock price will eventually come back up, then averaging down is great.  But, how about if you keep averaging down and buying more shares on weakness, and the stock just keeps going down without ever rebounding? This is the danger of averaging down, as you will continue to lose more and more money every time the stock price dips. 

Averaging down definitely takes a lot of courage, and you have to be willing to go against the market and buy when others are selling.  But, if you are investing in a solid company for the long term and are confident that its stock price will rebound, averaging down is one of the best ways to increase your profits.

 

Niki Pezeshki

College Trillionaire