Today you will learn exactly how to average down stocks.
In fact, these techniques helped me ride the trend and grow my account fast.
To help you with your trading, I’ll try to answer this question, “should you average down stocks?”
Most traders become investors when they average down a stock.
They do it because they probably hold a losing position.
Initially, they planned to get out of the trade as soon as the price decline significantly, yet they didn’t follow their plan and hold the stock anyway to ease the pain.
Invest additional amounts to average down stocks. If possible, the amount could be the same as your previous trade to lower the average cost of the stock significantly.
Question for you, do you think averaging down stocks is profitable?
Before you answer the question, let’s look at why stocks decline and the formula below.
Why stocks go down?
Stocks decline because of supply and demand. If the supply is high, the stock will decline because sellers will push the price down.
The more sellers are positioned at a particular price the higher supply, there is.
Stocks also decline because of profit-taking, and buyers have become sellers, especially in resistance levels.
I don’t like buying at resistance because there are so many sellers up there.
Well, I like to buy within 20% below the resistance level also, because I want to see if breaks it.
You can use this AFL code to find stocks near resistance.
resistance=8; //significant resistance level filter=resistance*.8;
This average down formula is simple to follow because it is done in excel. It lists the previous stock trades for easy calculations.
Let’s say you bought 1,000 shares at $10 per share, your total investment is $10,000.
After one month, the price has declined by 20%.
In the average down stock formula above, you will notice that lowering your average price is easy when your stock is down.
However, you are also increasing your trading risk when doing that.
It is usually painful for you that your account has a lesser value.
When this happens, Is averaging down a good idea?
The most common instinct of a beginner investor/trader is to average down to reduce the loss.
In the next month, you invested an additional $10,000 to reduce the average to $8.89 per share.
The break-even point is now at $8.89(20,000/2,250).
If the stock price trades back at $10, you have an unrealized gain of about $1 per share even though the current stock price is below $10.
If you add $20,000, instead of $10,000, the average price per share is smaller($8.57).
However, if the price on the stock continues to decline up to 20% more, your losses are now amplified.
For example, a 20% decline in a $10,000 account is only $2,000, while a 20% decrease in a $20,000 account is a whopping $4,000.
Can you see what will happen if you keep adding shares for every significant deep of the stock price?
I know what you are thinking. You’ll blow up your account sooner or later.
Always remember to honor your exit plan for every trade you take.
Because every time you add a position, you amplify your possible losses.
Buying when the stock price is low
Averaging down may look like a good strategy and buying when the price is low is more attractive.
For example, when you go to a store, and you find a shoe you like selling that is at a 50% discount, would you buy it?
When averaging down shares, you buy more shares at lower prices, but you are increasing your risks.
A price decline of stock can attract more buyers because it may look like a bargain.
However, we all know that it is the other way around. A bargain stock can remain cheap forever.
One may ask, what is the average down in stocks.
How do you neutralize the volatility of a stock? You can use Dollar-Cost Averaging to do it, and it is also good for dividend investing.
The approach is more of a passive strategy.
how to average stocks?
You are just accumulating stocks to grow your wealth over time, and also reinvesting the dividends.
Here are the steps:
- Determine the amount to invest every month from your paycheck.
- Select a stock(s) to invest.
- Buy the stock(s) every month regardless of the price.
Dollar-cost averaging works like this.
The number of shares you can buy depends upon the amount you decided to invest every month.
For example, if you only invest $100 per month, you can buy 12 shares at $8 apiece.
However, if the price has declined to $6, you can buy 16 shares on the stock.
The higher the price the lower the number of shares you can buy. The opposite is also true.
The lower the price the higher number of shares you can buy. You can always refer to the formula above.
You can add the total amount you invested and divide it by the number of shares you have to get the break-even price.
The stock price must rise above break-even for you to profit, assuming that there are no trading fees and taxes.
Dollar-cost averaging requires you to do extensive research to select the best stocks, although you opt to use a passive strategy.
If you selected a bad stock, you’ll be investing in losing the company.
Where can this investment take you?
Another disadvantage of dollar-cost averaging is the hidden trading fees.
Every time you buy a stock you are paying up the commissions, and over time the cost will go up.
The optimum way to reduce trading fees is to invest a lump sum.
Instead of buying stocks monthly, do it every three, six, or eight months to reduce the costs of trading.
It was found that averaging out of the share market is profitable.
However, there is a strategy you can use to get out of a losing trade that the pros use.
In this averaging down trading strategy, professional traders only average down the stock to get out of a losing position.
Let’s say the stock price declined to the support level at 10%, you can buy more shares to lower your price per share.
Then, get out at the pullback up to 50% of the total decline.
The strategy will help you reduce your trading losses, and it may reverse upward.
However, if there is a breakdown at the support level, exit the trade immediately.
Don’t want to amplify your losses, only take the smaller losses.
What to do when the stock goes down?
You can use the strategy above to get out of a losing trade, or just exit the trade and take the loss.
What is important is that your average losers are lesser than your winners.
Do not amply your losses by averaging down stocks, unless you use the strategy, I have shared above.
Always honor your stop loss to protect your investment.
There are many strategies you can use to become profitable in trading, and you can look at our recommended strategies to find out more about it.
Averaging down stocks is an account breaker if you abuse it.
Worse! If you double down the amount, you add in every decline.
Study the formula above to have a good idea about the break-even price, and only if you can’t control yourself.
If you must, then get out of the trade fast.
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