Friday, March 16, 2018

Should you 'average' down during a correction?

Interactions with small investors over the years throw up the same questions repeatedly. Here is a recent example:

"I bought 100 shares at 60. Bought 100 more at 80. The stock moved up to 100, but I didn't book profit. Now it has breached the stop-loss at 75 and fallen to 65. I am still holding. Can I 'average' now?"

Two mistakes have already been made: (1) not booking partial profits at 100; (2) not selling when the stop-loss was breached. Now the investor wants to 'correct' the two mistakes by committing a third - trying to buy a stock on the way down.

When a stock is correcting from a top, one needs to make an assessment of both the short term and long term trends. If the short term and long term trends are down, there is nothing to be gained and much to lose by 'averaging'.

There are no supports that can hold when bears go on the rampage. Better to take it on the chin and book a loss quickly instead of waiting for the stock to regain your 'buy' price. (Remember that the stock doesn't know or care about your 'buy' price.)

If the short term trend is down but the long term trend is up - in other words, a correction in a long term bull market - then 'averaging' can make some sense. 

However, the smart move will be to wait for the correction to be over and buy when the stock resumes its up move. This is easier said than done.

One has to be very savvy about support and resistance levels to decide when the correction is over and whether the resumption of the up move will be followed by another down leg or not.

That was the long answer to the question.

The short answer is: Never 'average' down. 'Averaging' on the way up is a better strategy.

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