Averaging down experience

[burglar]

Yes and I suppose the real answer lies in whether averaging down is, over time, a profitable trading strategy. ...

If you do it repeatedly you may win.
Eventually you will pick the wrong company.
I know I did, it cost me bigtime!
Not only in money terms but the setback in time as well!

 

[nomore4s]

My views on this matter are probably a bit different to most.

I never average down in my trading accounts as that really does defeat the purpose of trading.

But there are times I will buy stock at a lower price to my original purchase in my long term investment portfolios but this is a part of my strategy and not something that happens a lot. I also would never do it while using leverage of any sort.

If averaging down does become apart of ones strategy it is important to remember a few things. Firstly every-time you average down you are increasing your risk and doing it while already being behind (already holding a losing position), so your strategy needs to be able to take this into account for the benefit of both your emotional and financial states. Second you need to understand exactly when, why and what stocks you would average down with because like skc said averaging down on stocks like ABC, BNB etc will put a serious dent in your capital but if done with quality stocks at the right time it will obviously be very beneficial.

Would I recommend a beginner incorporate averaging down into their plan/strategy? In short no.

 

[Julia]

Of course averaging down works when the price goes back up.

Average down on AED or Babcock or ABC learnings and it's a disaster.

Average down on CBA or MND or MMS and you would have done well.

We can all come up with examples of how averaging down worked for somes shares and didn't work for others.

The problem is not averaging down per se - it is the fact that the investor/trader was no good at picking stock or recognising change in the first place. For the average investor/trader, adopting a "NEVER AVERAGE DOWN" stance may be prudent, but it doesn't make it gospel.

Great summary.
I've never averaged down and never would. Holding falling stocks makes me totally uncomfortable.

But I remember after the worst of the GFC falls we had a conversation a bit like this one, and a few posters described how well they had done by indeed averaging down on companies they were confident would come through well.

They were right: those companies did recover quickly and well.
So perhaps the strategy should not be written off but rather regarded as sometimes useful if you understand the companies concerned well, and have enough experience to justify your expectations of their recovery.

 

[tech/a]

Great summary.
I've never averaged down and never would. Holding falling stocks makes me totally uncomfortable.

But I remember after the worst of the GFC falls we had a conversation a bit like this one, and a few posters described how well they had done by indeed averaging down on companies they were confident would come through well.

They were right: those companies did recover quickly and well.
So perhaps the strategy should not be written off but rather regarded as sometimes useful if you understand the companies concerned well, and have enough experience to justify your expectations of their recovery.

Julia.
You'll note when an index crashes there is ALWAYS a good bounce.
if you time that right then it can work well.

But buying in any bear run which extends over a longer period is plain crazy.---in my opinion.

 

[burglar]

... sometimes useful if you understand the companies ....

Hear hear!!

 

[Julia]

But buying in any bear run which extends over a longer period is plain crazy.---in my opinion.

No need to persuade me of this, Tech. I agree absolutely. Just trying to be objective about what has apparently worked for others.

 

[So_Cynical]

Hi All,

I'm still building my investment/trading plan and thinking about different strategies to employ for my long term investment decisions, and short term trading decisions.

In terms of long term investments, what are your thoughts/experience on an averaging down strategy if the situation arises to purchase additional shares at a discounted price?

My last 3 (completed) average downs as posted in real time in this forum.
~
https://www.aussiestockforums.com/forums/showthread.php?t=17040
https://www.aussiestockforums.com/forums/showthread.php?t=14605&page=2
https://www.aussiestockforums.com/forums/showthread.php?t=7127&page=3

I have a few more but no charts..and a few more but they are actually slight averages up....so don't let anyone fool you into thinking averaging down never works cos im proof positive it does work....averaging down is a core part of my wealth creation strategy.

Charts below.

 

[suhm]

I will average down based on news if there is a trend reversal or if the news is good.

I will also average up based on news.

I tend to hit the sell button if news is not forthcoming and the sp is in a decline and sp is not supported by cash or strong past or expected cashflow/earnings.

I pretty much trade based on expected newsflow and what I percieve as fundamentally undervalued companies in an uptrend.

 

[Reasons]

Julia.
You'll note when an index crashes there is ALWAYS a good bounce.
if you time that right then it can work well.

But buying in any bear run which extends over a longer period is plain crazy.---in my opinion.

I am never totally comfortable psychologically doing it, especially during a down swing as hard as the GFC, but in reality it is actually nothing more than a logical and calculated risk-reward bet with something like a bank in the ASX top 20.

Eg, once the price has crashed down to a point that it is delivering ~10% net dividend, what is the likelihood of it dropping from its present price and delivering say a ~15-20% net dividend and holding that level because no-one will ever be interested in the risk of an ASX top 20 share unless it is providing a 15-20% net return, as opposed to finding support and going up again to at least slightly more normal levels? Fairly high; just does not feel that way at the time. If it keeps dropping you keep buying based on your logic.

I learnt that this is not the time to tell anyone else what you are doing either or to listen to the press much as everything negative and more about such a tactic will be slung at you and bring illogical fears to the forefront instead of the straight forward risk-reward logic of the tactic.

Once the price snaps back up, you are already set so that larger move is then easy to capture and you are not trying to judge the entry. It is a 10-20% capital risk strategy only, preferably diversified over a number of shares (capital protection and psychological risk management when spread). Holding for the next couple of years to maximise the profit can prove harder. General feeling is that you need to hit yourself over the head with a hammer after executing and wake 12 months later to evaluate your decision

 

[Boggo]

I am never totally comfortable psychologically doing it, especially during a down swing as hard as the GFC, but in reality it is actually nothing more than a logical and calculated risk-reward bet with something like a bank in the ASX top 20.

Eg, once the price has crashed down to a point that it is delivering ~10% net dividend, what is the likelihood of it dropping from its present price and delivering say a ~15-20% net dividend and holding that level because no-one will ever be interested in the risk of an ASX top 20 share unless it is providing a 15-20% net return, as opposed to finding support and going up again to at least slightly more normal levels? Fairly high; just does not feel that way at the time. If it keeps dropping you keep buying based on your logic.

You sound like one of those Telstra 'investors'.

 

[Reasons]

You sound like one of those Telstra 'investors'.

Probably similar logic in some ways now you say it as once Telstra's price gets too low, the high dividend will bring the buyers in because they consider they are are being rewarded sufficiently for the risk taken. I will only occasionally undertake this particular tactic near what I am guessing at the time to be close to capitulation of the last sellers in fairly dramatic market circumstances, and during the GFC with equities that were likely to be back-stopped by the government if all else failed.

The tactic is most definitely not investing, it is a calculated risk-reward bet in your favor with potential for higher than normal losses, but if you had held from the GFC until now it was a damn good investment from a capital gains and dividend perspective.

 

[danbradster]

...unless a 10% fall in SP is just the precurser to a further 20% fall

...picked a good undervalued company...

"10%+ fall in SP, <b>for no good reason</b>"

How is it a good opportunity? A stock will rise or fall depending on the willingness of people to buy or sell that stock. If it's fallen 10% then more people are selling than buying - that is not a positive sign. Doing this you have your funds tied up in an asset that's deteriorating in value and will require an unknown length of time (potentially years) just to break even, let alone make a profit.

If it's falling in value why not get out quickly, cutting your losses short and waiting until their is support for your stock in the form of buyers and jumping in then? You preseve your capital and will get in at a better price than someone averaging down. Problem is it takes more effort and the willingness to upset you messed up and bought at the wrong time. The latter is what most people seem to struggle with.

If your investment is not making you money, you paid too much or bought at the wrong time.

Just saying that the strategy has worked for me more times than not.

If people are selling for bad reasons, then I top up. Like for example if the gold price fell by 1%, a gold miner will likely fall in SP. But if the AUD also fell by 2%, then their profitability will actually improve...but chances are the market won't realize it, they are blindly selling. I am buying here.

Or when OAK:ASX announced that the CEOs shares went into receivership, the SP fell 30% the next day, again blind selling, I was topping up. A few months later the SP has doubled.

If you have a quality company that's undervalued and becomes more undervalued, then it's time to top up. It's impossible to pick the bottom every time...having an average buy-in near the bottom is good enough.

I sometimes even enjoy the market down days. It allows me to sell my holdings that broke even or rose and average down on the ones that fell. When they recover to where they started you're in profit. Rinse and repeat selling high ones and averaging down the low ones.

I hold about 15 different shares at a time and have been making a strong profit in the sideways market.

I sometimes have to cut my losses, if the news is long term, but usually I don't have to. I am ok with a 1 year wait for a company to realize a SP closer to its true value.

 

[Nortorious]

Thanks to everyone who has contributed to the discussion thus far. It has been excellent to hear the views and experiences from both sides. I'm learning a lot thanks to all of you!

 

[sinner]

IMO if you're skillful enough to know that an index has been dampened due to a recency bias and is due to return to normal levels soon, you shouldn't be averaging down - you should be selling all that you hold and waiting until the index hits support and then buying in.

E.g. plenty of people sold on the Japanese tsunami ASAP and bought in a few days later when the fall had become overextended and positive news (and buyers) started to return. If you're experienced enough you can see these things coming (although you cannot predict them with certainty or time them with certainty of course - but you can get close).

Simply put: Every time you average down you're wrong - You paid too much or did not buy near the bottom. If you were right about a stock you wouldn't need to average down. Hence no use compounding a loss. Kill it while it's small and wait for the moment when you feel that events leading to the initial recency bias are slowly being resolved and then jump in on the positive upswing and momentum.

I disagree with your "simply put". Every time you average down you are wrong? What if I have a trading plan like:

* At the start of every quarter, allocate 10% of net quarterly savings to index fund.

That's just an example, but there are plenty I can think of where averaging down is not "wrong".

I know some FX traders who like to "sell a little on the way up and a lot on the way down" or "buy a little on the way down and a lot on the way up", these guys have a turnover and bottomline P&L that makes me green with envy. I have my own intraday strategy based on correlation which does this too. Are we

"wrong"

 

[Julia]

Can we extend the discussion to a particular stock, let's say RIO, which today is down more than 1%, extending losses over earlier days.

The XJO and XAO are down by about half a percent.

Do you buy this now and continue buying if it continues to fall?

If you are holding and would, in terms of your usual criteria, be stopped out, sell?

Or do you say, hey of course it will turn back up again?

Or, in the face of the rising $A dollar which doesn't look like changing its upward course, do you consider the SP of RIO, and other big miners and manufacturers for that matter, will continue to be depressed?

 

[tech/a]

Every time you average down you are wrong?

I would say.

(1) Poor risk management.
(2) Inefficient use of funds----- opportunity cost---heat---portfolio balance
(3) Poor analysis skills.

But others may like the idea.

 

[bbker]

It will turn back up, but when? You also have to decide when to start averaging down.

With the strengthening Australian dollar, and investment moving out to the cheaper overseas markets, you would be averaging up!

Can we extend the discussion to a particular stock, let's say RIO, which today is down more than 1%, extending losses over earlier days.

The XJO and XAO are down by about half a percent.

Do you buy this now and continue buying if it continues to fall?

If you are holding and would, in terms of your usual criteria, be stopped out, sell?

Or do you say, hey of course it will turn back up again?

Or, in the face of the rising $A dollar which doesn't look like changing its upward course, do you consider the SP of RIO, and other big miners and manufacturers for that matter, will continue to be depressed?

 

[KurwaJegoMac]

I disagree with your "simply put". Every time you average down you are wrong? What if I have a trading plan like:

* At the start of every quarter, allocate 10% of net quarterly savings to index fund.

That's just an example, but there are plenty I can think of where averaging down is not "wrong".

Firstly that's not really averaging down, that's a trading plan where the profits are made by paying the 'average' price of the index fund over a year by purchasing in a few lots, with the expectation that the market will continue it's increases.

But if you don't see it that way:

Personally I still see that as being "wrong". If you were right about your analysis than you would be holding your capital and buying into the index funds at times that will start generating you returns as soon as you invest, not tying up your capital in periods of downturns.

Averaging down, by the very nature of the technique, requires you to purchase additional shares at a price below what you originally paid - therefore you were wrong in your initial analysis and are attempting to compensate by lowering your cost basis and bring it closer to your second entry price (which you are hoping will be correct). The cycle repeats until either your stock hits a bottom and reverses, stagnates or delists.

If your analysis was right in the first place you'd be in the 'black' straight away rather than being in the 'red' and needing to bring your cost basis down.

I know some FX traders who like to "sell a little on the way up and a lot on the way down" or "buy a little on the way down and a lot on the way up", these guys have a turnover and bottomline P&L that makes me green with envy. I have my own intraday strategy based on correlation which does this too. Are we

"wrong"

Yes you are still wrong even in this example as you had to purchase on the way down. Put it this way: say you're looking at a fictional stock XYZ - by some divine measure you know for a fact it will go down in the short term. Would you buy this stock and average down? Of course not - you know it's going down so you'd wait and buy it at a cheaper price right? Why on earth would you buy in, knowing it'd go down tomorrow, and then attempt to average down? Nobody would do that of course - but that's what the average down strategy is.

 

[Boggo]

Can we extend the discussion to a particular stock, let's say RIO, which today is down more than 1%, extending losses over earlier days.

If you are holding and would, in terms of your usual criteria, be stopped out, sell?

Or do you say, hey of course it will turn back up again?

Personally, assuming that I had got in on the run up then I would have been stopped out either at the break of the 83.63 or otherwise definitely at the break of 82.00.

My simplistic view is that anything below 82.00 is in negative territory, between 82.00 and 89.00 is sideways and above 89.00 is back to the positive overall trend.

Not wanting to involve EW in the discussion but if there was a clearly defined ABC within the area between 82.00 and 89.00 then I would be prepared to enter with a tight stop.
This is not the case with RIO but as an aside if you look at a chart of MND it may still be until it tells me otherwise.

In either RIO or MND I would not be still holding, I would rather be watching from the the sidelines.

PS - It will turn back up Julia, I don't believe that that is a reason to hold on while its going down but maybe thats just me

(click to expand)

 

[skc]

...picked a good undervalued company...

Or when OAK:ASX announced that the CEOs shares went into receivership, the SP fell 30% the next day, again blind selling, I was topping up. A few months later the SP has doubled.

Don't think OAK is a high quality company... and it doubled on a takeover offer. So probably not the best example imo.

This is not the case with RIO but as an aside if you look at a chart of MND it may still be until it tells me otherwise.

In either RIO or MND I would not be still holding, I would rather be watching from the the sidelines.

Hey Boggo, can you do an experiment for us/me? Can you apply your trading methodology to the MND chart from say Nov 2008 (where it was the lowest low) and tell us what trades you would have done? And P/L if you just apply a 2% rule?

Quite separate from the averaging down discussion, but more about 'buy and hold'

Don't worry if you method isn't 100% mechancial or it will take too long.

Thanks.