Trading Basics: Evolution of a Trader

DID YOU AVERAGE DOWN?

If you are a day or swing trader, then do not average down. I have already explained why in Chapter 2. For position traders and buy-and-hold investors, then buying when price drops to lower the average cost works, but only if the stock recovers.

My biggest loss—ever—came from a long-term investment in Gencorp (GY) when I bought the stock in 2007 before the bear market began and averaged down only once. In 2008, fearing the stock was heading toward bankruptcy, I finished selling my shares just three days before the stock bottomed. Three days! The stock moved sideways for eight months and then started recovering, quadrupling in price in five months.

I have averaged down just 6 percent of the time over 30 years and 55 percent of them were profitable, returning only $21 in average profits per trade. That return barely covers commissions, and it certainly does not justify the risk involved.

If your trading plan says an investment is worth buying more as price drops, then do so carefully. Watch your position size. For example, if you buy a position in a stock for $20,000 and it is worth $5,000 now, you may be tempted to throw another $15,000 to bring it back up to $20,000. That would mean an initial investment of $35,000 ($20,000 + $15,000), concentrating too much of your assets in one stock, even though current values say otherwise.

Should you decide to average down, then do so only once, and do not throw too much money into the stock. If you are right, the stock ...