Say if I buy a stock today at RM 1.00. Unfortunately the share price drops to RM 0.90 a few days later. I decided to purchase additional units of the stock. Say if I purchased the same quantity as the other day, then my average entry price is RM 0.95. In this case, I do not have to wait until the share goes back to RM 1.00 to break even, RM 0.95 is enough.
The idea of average down is simple. It sounds nice, as if averaging down will be easier to break even or even making profit. However, from my experience, average down has mostly resulted in horrendous outcome. I lost even more, let alone trying to break even.
Firstly, if a share drops 5-10% in a short time after buying, it means that I did not wait long enough to buy at a lower price. This implies that I made an impulsive decision to jump in. An impulsive decision is usually an emotional one. Stock market cannot allow emotional decision. This reason alone is good enough to lose money.
Secondly, my attitude of averaging down is horribly wrong. I admit that I carries a sense of gamble (a legacy?) when average down, longing that the more I average down, the easier it will to break even. Additionally, the action inevitably accompanies a feeling of vengeance. This emotional state itself is negative in nature. Negative emotion always resulted in negative outcome. And the market has never failed to give me a lesson on this.
Thirdly, and technically, it may be that the stock is in the down trend. If the share keeps on dropping, cut loss might be a wiser choice than average down.
Interestingly, on the other hand, if the share goes up shortly after I buy, "average up" usually brings even more return. Maybe earning money shortly after buying is a sign that the purchase is a good decision. Nevertheless, the psychological barrier to buy the stock at a higher price is much stronger than average down. This is human nature: if I can buy an item at RM 1.00 today, why would I pay for RM 1.10 in the next week? But my experience proves that this is a better way. So overcoming the psychological barrier to "average up" is an important way to make more money? Yes, I believe so.
http://chonghe-investment.blogspot.my/2016/06/the-technique-of-average-down.html
