Today you will learn exactly how to average down stocks.
In fact, these techniques helped me ride the trend and grow my account fast in the stock market.
- Why stocks go down?
- Formula: How to calculate?
- Buying when the stock price is low
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 at the current share price.
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.
To Average down stocks, you can add more shares when the price is 30 to 50% lower than the previous price. The number of shares added to the portfolio should be equal to or more than your previous trade. Because if it is lower, the price will not be lower than the intension.
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.
Average down is a technique used in trading to lower the cost of acquiring stocks through buying additional positions at lower prices, considering that the security has traded down. The technique may look like an excellent strategy. However, if the asset’s price continues to go down, the risk of losing the capital is eminent.
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 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 enjoy 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;
The formula – Stock Average Calculator
This average down formula is simple to follow because it is a calculation done in excel, similar to simple moving average. It lists the previous stock trades or stock positions for simple calculations.
To calculate averaging down in stocks, add the total amount incurred and divide it by the total number of shares bought. The total amount of costs should include the commissions and other fees paid.
Buying additional shares to lower average is a strategy to eliminate losses when the asset has gone down. It seems a reliable system if the trader has unlimited capital. However, if the capital runs out, the losses will be bigger when the stock’s price continues its declines.
Let’s say you purchase 1,000 shares at $10 per share for your investment portfolio. Your total investment is $10,000.
After one month, the share price has declined by 20%.
In the average down stock formula above, you 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 in the investment strategy to reduce the loss.
In the next month, you invested an additional $10,000 to reduce the average to $8.89 per share (Dollar cost averaging).
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, when the price on the stock continues to decline up to 20% more, your losses are now bigger.
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, eventually.
Always remember to honor your exit plan for every trade you take.
Because every time you add a position, you make your losses bigger.
Break Even – Stock average down
Average down stock to break even is a technique used for exiting a losing trade. It is a onetime method to get out before the stock falls further. Usually, one can use this at a perceived strong support price to capitalize on a bounce trade and exit immediately at a break-even price.
How many shares to average down? Usually, the number of shares to average down is equal to or more than the last trade for some traders. Traders often have a total number of shares and divide it into four parts to average down at significant support levels. Thus, they can reduce the risk of taking trades all at once.
Buying when the stock price is low
Averaging down may look like an excellent 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.
How to lower average cost of stock? To reduce the average cost of a stock, you can buy more shares at lower prices. You need to get the same number or more shares from the last trade at lower prices to make the average cheaper. However, this will cause adding more risk for the buyer.
Dollar-Cost Averaging (long-term investor)
One may ask, what is the average down in stocks.
How do you neutralize the volatility of a stock? You can use Dollar cost average, and it is also good for dividend investing.
In this investing strategy, the approach is more of a passive strategy for stock investors and is usually suitable for bull markets.
how to average stocks?
You are just accumulating stocks to grow your wealth over time, and also reinvesting the dividends.
Here are the steps for a Dollar cost averaging strategy:
- 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 on the amount you invested 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 at the break-even price or average purchase price.
The stock price must rise above break-even for you to profit, assuming that there are no trading fees and taxes.
Caveat for inexperienced investors
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 using your money, 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.
Also, blue chip stocks and large market cap companies are suitable candidates because of its stability.
Another suggestion is to look for growth stocks. These stocks can still go up although there are pullbacks.
However, in a bear market, averaging down may be risky.
It is risky because almost all stocks are going down, and no one has unlimited capital to buy at the bottom.
Falling stocks are bad for DCA.
A strategy of averaging down will be profitable if there is luck and unlimited capital.
However, people have limited capital to invest in the stock market, which may cause a lot of losses.
Average Down Strategy
As a general rule, average down strategy is a strategy used to lower the price of the stock, which is useful for exiting previous trading positions. Although the risk is high, there are strategies when applied can help traders get out of a losing trade or stock position.
We 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 and absorb the market volatility.
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.
It is important is that your average losers are lesser than your winners.
Do not make your losses bigger by averaging down stocks, unless you use the strategy I have shared above.
Always honor your stop loss to protect your investment.
Is it smart to average down stocks? It is not usually wise to average down stocks considering that the risk is more significant every time there is averaging or increasing positions at lower prices. Averaging requires more capital, which is not usually available to retail traders, resulting in more losses because the stock is still going down.
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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