COMMENT
When Averaging Down Makes Sense

Some stock market pundits think they can call the bottom of a share with accuracy. Personally, I've never quite mastered that skill. After all, who's to say that just because a share is a screaming buy today that it won't shriek even louder tomorrow?

Consequently, I've concluded that bottom picking is a pointless exercise. Instead, I prefer to average down, which has been considerably more rewarding for me. (By averaging down, you buy additional shares in a company that you already own that has dropped in price since an earlier purchase.)

So, whenever I find a share that looks cheap, I will only buy half of my intended position. After a month or two, I will review my position. If the shares have fallen but the fundamentals remain unchanged, I will buy the other half. That way I get more shares for the same money. And with the plethora of low-cost brokers, the extra dealing costs this approach incurs are minimal.

Of course, if the fundamentals of the business have deteriorated I can walk away with just half the losses. Mind you, if the shares have risen, I am left with a number of pleasing options too. I can buy more, which is known as averaging up, sell part or all of my holding, or just do nothing.

Averaging down is seen by some investors as a lame strategy, but I have to disagree with them strongly. Opponents of averaging down assert that if you intend to buy a share then you should have enough conviction to buy it wholeheartedly. But let's not forget that shares can sometimes move without rhyme or reason. So, averaging down can be a good way to hedge against this.

It's also important to distinguish between averaging down to cut trading losses, and using the strategy to even out market fluctuations. In the former, you are compounding a mistake by throwing good money after bad, but in the latter you are simply getting more bangs for your bucks!

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