Averaging

3 Key Takeaways

• Averaging is an investment strategy to lower the average cost per share.
• It involves buying more shares as the price decreases.
• This strategy can be risky if the price continues to fall.

What is Averaging?

Averaging, also known as averaging down, is a strategy used by investors to mitigate losses and potentially improve their overall return on investment. It involves purchasing more shares of a stock or other asset after the price has declined from the initial purchase price. By buying more shares at a lower price, the investor can reduce the average cost per share, which can help offset previous losses if the price eventually rebounds.

Importance of Averaging

• Loss Mitigation: Averaging can help investors reduce the impact of losses incurred from a previous purchase of a stock or asset that has declined in value.
• Potential for Increased Returns: By lowering the average cost per share, investors can potentially achieve higher returns if the price of the asset recovers.
• Psychological Benefit: Averaging can provide a psychological boost to investors, as it allows them to feel like they are taking action to mitigate their losses and potentially turn the situation around.

How Averaging Works

1. Initial Purchase: An investor buys shares of a stock or other asset at a certain price.
2. Price Decline: The price of the asset falls below the initial purchase price.
3. Additional Purchase: The investor buys more shares of the asset at the lower price.
4. Average Cost Calculation: The average cost per share is calculated by dividing the total amount invested by the total number of shares owned.

Real-World Applications

Averaging is a common strategy employed by investors in various financial markets, including stocks, bonds, and commodities. It is often used by investors who believe in the long-term potential of an asset but have experienced short-term price declines. However, it is important to note that averaging can be a risky strategy if the price of the asset continues to fall. Investors should carefully assess the fundamentals of the asset and the overall market conditions before implementing an averaging strategy.