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After you have bought a stock and its share price drops, you buy
more at a lower price. This brings the average price per share down.
This is called averaging down. The exact opposite is averaging up. Most people like to average down. Is this a good strategy? It
all depends on who you are financially and your personal traits. If you
are a value investor, that is, an investor who buys sound solid
companies at undervalued prices for the long term, you should certainly
average down. Buy low and sell high is your way.
But, if you are a speculator or trader, your strategy would be to buy high and sell higher. Your tactic is to ride with the waves. You don’t want to wait. So you have to time your purchases. That means you wait for the stock to move first before you buy. A
trend can reverse direction at any time. As soon as you buy, the price
drops. Your positive expectancy vanished. In this case, you must
quickly sell to keep your losses small. Don’t compound your error by
averaging down. If you are right, you can average up. There
is no way you can win all the time. The important thing is not to get
the best of cards but in knowing when to leave the table. In other
words, you must know where to correctly place your stop-loss. That’s
the difficult part of the problem. To win, keep you losses small and profits big.
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