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Averaging down is the act of buying a company’s stock at a higher price and then buying the same stock at a lower price. This way we can quickly get profit beyond our capital amount when the stock goes up. Does this apply to all stocks? When should it be used? Let’s see.
Averaging is like that for those who have been investing and trading in the stock market for years. People who are new to the stock market may have doubts about what averaging is. It’s an easy one.
For example you buy 100 shares of Axis Bank for Rs.700 (700*100 = 70,000). In a few days the shares of the company fall to Rs.650. Then again if you buy 100 shares, the average price per share you have will be Rs.675. (70,000 + 65,000 = 1,35,000) Divide it by 200 shares to get the average price. By doing this we reduce the price of the stock we bought earlier by Rs.25. When this stock goes back to Rs.700 our profit will be Rs.5,000. If averaging is not done. No profit will be made.
Will this reduce the loss?
Averaging will reduce our loss if not less. A loss of Rs.50 per share does not mean a loss of Rs.5,000 per 100 shares. Only the price of the already purchased stock will be reduced from Rs.700 to Rs.675.
When can you do averaging down?
There are no rules for this. A company’s fundamentals remain constant. But if the price falls due to any sudden news or cyclical gainers selling the stock, then the stock can be bought and added significantly if it is found to be suitable for the long term.
Strategies vary from person to person
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Some will average if the good stock they bought falls 10%, some will average if it falls 5%. If the averaged stock price falls further, the loss will increase further. Because where we used to have 100 shares, now we have 200 shares.
So this can be done for long term only in stocks which are known to be undervalued. Stock market gurus like Warren Buffett have seen fat profits by using the averaging down strategy correctly.
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