Averaging up or averaging down? 1 comments

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For those unfamiliar with these terms, averaging up means accummulating more of a stock as its price goes up (buying with the price trend), while averaging down means doing so as the share price goes down (buying against the price trend).

This is a big question to many new market players and brings quite a lot of confusion to them, not least because of the seemingly conflicting advice that are given by well-known market personalities. Jesse Livermore among many others advised accummulating more of a stock only after observing price uptrend following the initial purchase; Warren Buffett says why do you resist buying more of a business that you are sure about if its cost (the price) quoted by Mr Market goes down?

One thing is clear: there is no absolute answer, as with most issues within the investing field. One observation is that most short-term traders tend to favour the averaging up technique because they believe in getting more of a stock that shows them profits, and also they like to invest with the trend/momentum. Allied to this technique are two things: (1)the traders' strong discipline in cutting losses if prices go the unfavourable way, so that effectively they let profits run while trimming losses fast; (2)their strong reliance on reading key support levels and so-called breakouts out beyond these levels suggesting renewed momentum which in turn generates a buying signal. On the other hand, investors with longer holding horizons tend to believe in accummulating more of a stock if its price falls to a significantly lower level than the original purchase price, as long as they believe company long-term fundamentals have not changed. This technique is often linked to (1)strong background understanding and research on the companies; (2)concentrated portfolio of a reasonably low number of stocks which allows these investors to focus their undivided attention on their few stock holdings.

Two things to me, however, are indisputable: firstly, underlying business trend is more important than price trend: a rising price often might indicate improving business fundamentals and hence giving weight to the averaging up argument; while long-term investors are not wrong either if they choose to buy more at lower prices if they think business fundamentals have not weakened. Secondly, an advisable course of action is to buy a portion of the stock initially instead of purchasing the entire line at one go; this is useful as a risk control tactic and provides the individual with the monetary means to take advantage of further price or business fundamentals developments.