Today, you’ll learn about the average share price formula.
- What is an average share price?
- Calculating average share price
- Proper way to use average price.
An average share price formula is equal to the total costs(including commissions and fees when buying and selling) divided by total shares either bought or sold. It is used to find the break-even price of a stock.
A trader needs to know how to compute an average share price formula. He must also use it every time he trades to avoid losses. For example, buying a stock at $5 per share and selling it at $5.02 does not mean he earned a profit.
The average price changes when the trader adds positions, and he needs to track it. When he reduces his exposure, the average price does not change.
Most trading platforms add only trading fees when taking the positions, and they do not include fees during exits.
A trader needs to be careful when looking at the data. He has to compute the actual average price himself.
Trading involves commissions and fees also. These are added to the costs which can break or make a trader. Most trading websites and gurus do not discuss this.
A new trader often learns to add commissions after his first trade, thinking that he made a buck, yet he incurred losses. He needs to understand this idea.
When John started trading, he did not have this knowledge. Just like anyone else who experienced losses, yet he records his trades to learn from it.
Now, he wants everyone to have the truth.
An increase of two percent in a stock price is only at break-even if the commissions and fees is also two percent.
Learning a concept like this can help a trader a lot, for it is essential.
However, one should read the John’s warning below. A trader should not average down a stock. If he does, he is risking his entire trading account.
Let’s discuss this in detail below.
What is an average share price Formula?
An average share price formula is important to traders which look like this:
According to Investopedia, an average price is the mean price of an asset or security. (source)
Therefore, the formula is simple for a trader to follow.
For example, a trader took two positions at $4.50 and $5.00 a share. He can calculate the average price using the formula above which is equal to $4.86. The transactions can be either long or short positions.
Long position is buying and short position is shorting the stock.
If he bought back the stock, the trader needs to sell his positions above $4.86 to earn a profit, or he can sell at break even.
He must compute the average price to succeed in trading. Without a concept like this one, how can he know where to unload his positions.
Most trading platforms do not include the total commissions to compute the average price, because most brokers wants to earn from the account holder.
A confused trader is always a cash cow, and brokers love him.
However, one can still trade properly if he computes the average price manually using the formula above.
He can also use the Excel file below or download it for free. A user can use it for computing the average price.
The formula is easy to use, and a trader can share it to other traders also. He can modify it if he likes.
Some traders use the formula above in their trading journal. It can help them to earn more in the stock market.
No matter how good a trader is, he should have a good trading journal.
Averaging down warning
Now, a person reading this post might say,” This is easy, and I can now average down or up my stocks”. Well, he is absolutely wrong.
Trading is not easy for a beginner or professional. A risk of losing everything always exists.
A trader who is averaging down increases his risk. He will probably blow up his trading account.
There are a lot of horror stories of losing the entire capital. Furthermore, they already knew of the average share price formula, and they know what to do.
However, why did it happened to them?
Well, this is the answer, and it will make it clearer now.
A 10% decrease in stock price of a $5,000 position is only $500, yet in a $10,000 position, it is $1,000.
If the stock price keeps falling, and he keeps on average down, a trader will eventually have no buying power. He will probably lose his entire trading account.
Unless, he stops averaging down, and he applies good money management techniques, he will continue losing.
A few traders might get lucky, and they may not stop. However, it is not really a good idea.
Based on experience, many traders are going to have big losses in the first three months of trading, because they average down.
A more detailed explanation is written below to help traders improve their money management.
Proper way to use it
A good way to use the average share price formula is not through averaging down.
The trader should learn from his mistakes. What he needs to do is to find a good trading system, learn about risk-reward ratio, and follow everything.
Instead of using the stock price for reference, he can use average share price formula to set his target profits and losses.
A simple concept like this can make a huge difference in stock trading.
If a trader do not want to use a spread sheet for calculations, he can use the magic trick, below.
For example, he can multiply the stock price by 1.02 to get the average price if the commission and fess, for buying and selling the stock is two percent.
A technique that only works when not adding additional positions. When a trader adds more positions, at different stock prices, it will not work. He has to compute the average share price manually.
The lesson is clear, and traders should not average down or up to use the average share price correctly.