What is the averaging down stocks strategy and how does it work?
The averaging down stocks strategy involves making an initial investment purchase and then buying more of the same stock at a lower price if it drops from the purchase price. Investors generally use an average down strategy based on the logic that if they liked the stock at a higher price, the stock is an even better deal at a lower price.
Buying more shares at a lower price also reduces the breakeven point of the overall trade. The shares purchased at the lower price start making money if the price rises above it. This offsets the loss of the shares purchased at the higher price.
The goal of this strategy is to average down on stocks and then sell at breakeven. However, averaging down assumes that the stock will go back up. That sometimes happens, but not always. Also, it is unknown when the stock will go up.
What is an example of this strategy?
Assume that an investor or trader buys 100 shares of stock at £355 apiece. The price then proceeds to fall to £330. The investor or trader still likes the stock and, therefore, decides to buy another 100 shares at a lower price.
Use the average down stock formula below to calculate the new breakeven price:
[(# of shares x purchase price) + (# of shares x second purchase price)] / total # of shares
[(100 x £355) + (100 x £330)] / 200 = £342.50
If both purchases are for the same number of shares, add the two purchase prices and divide by two. If you have different quantities of purchases, use the formula above.
The average price for buying the 200 shares is £342.50. This is also the breakeven point. If the price rises to £342.50, the investor or trader will have zero loss or profit. Any price above £342.50 will show a profit, and if the price is below £342.50, the position is losing money.
What if the trader purchased 100 shares at £355 and then 200 shares at £330 (see the relevant calculation below)?
