James, about averaging down.
First off, let me just say that for very experienced investors who have deep pockets and have done the research to support their belief to average down on a stock, it is all well and good. There are definately cases where it can be a good idea.
If you are NOT one of those investors I just mentioned, averaging down can be disasterous. Throwing good money after bad, and all that. Especially if it's a downtrending stock. It is very hard to know when a stock will stop downtrending.
Every experienced investor uses a set of guidelines and rules to trade by, this creates discipline. And you cannot be successful without discipline in this biz. But each person's trading rules are established by his own personality and ability to take and handle risk. The rules are made to help manage risk.
That said, one of my rules to help manage risk is to only invest in stocks that are trending up. If the stock then pulls back a bit, it can offer an opportunity to average down, as long as it remains in an uptrend. But when most people talk about averaging down, they are refering to stocks that are downtrending. If the stock then takes 2 or 3 months to get back to the average cost, that is 2 to 3 months your money has not been working for you.
Also, being disciplined means setting your exit price when you buy. Deciding what price you will sell should the stock tank or drift lower. Averaging down is usually an unwillingness to admit you made a mistake in buying the stock, postponing the dreaded decision to sell at a loss. The end result can mean taking a 50% loss eventually instead of merely a 20% loss.
I said I could talk for hours about this subject, but I won't now. I think this pretty well sums up the dangers. I for one would much rather average UP. Or average OUT...selling parts of my holding to lock in profits and let the rest keep rising.
Kevin |
