Cost averaging or "averaging down" is an investment strategy used by investors to accumulate shares of a stock strategically based on per share price. A investor purchases more shares to add to a position of existing shares when prices are cheaper or when prices are higher, whenever they add to their position either as prices are more attractive or if the stock price increases.
Dollar Cost Averaging is highly successful stock trading strategy that allows an investor to put additional money into a particular company to build a larger position over time. The purpose for this method might be to lower the total average cost per share of an investment, giving the investor a cheaper overall cost per share on the investment by adding more money to previous purchased shares.
This strategy is actually a very smart one and can be a great method to earn big profits, but requires some discipline on the part of the investor. The “cost averaging” part of the equation is mostly a byproduct of market volatility: investors are able purchase less stock as prices go higher, and more as they go lower, therefore averaging down on the cost per share at the correct times when it occasionally dips could be extremely beneficial when the investment rises and having owned those addition shares.
Another positive aspect of DCA is that it allows investors to avoid investing too much into a stock when it is priced too high and helps traders add to a position when the stocks price is lower, thus reducing overall price per share. However, this method of trading ignores simple logic, common sense would suggest it's better to invest it all at once. Fortunately, smart investors and advisors do not always base their decisions on logic or evidence. However, when it comes to trading the stock market investors emotions usually plays a far greater role in decision making than logic.
Dollar cost averaging is an important trading strategy, but it should never be viewed as the only way of maximizing profits, nor does it suggest that you never invest a lump sum as part of your investment game plan. Relatively, it should be regarded as a solid risk reduction strategy suited for investors who are normally cautious in regards to a long term investment approach, because of the fear of market instability.
When markets are weak and sinking it can be difficult to foresee a clear path to take. Sensibly, people get worried when experiencing a big decline in the value of their holdings, but by staying focused and maintaining your trading strategy and averaging into your current investment can be intelligent valuable decision.
The main reason we tell our subscribers to average down is when they can bring down their average cost of a stock they are holding quite substantially. Assuming of coarse we believe the stock will turn around, this decision will ensure a lower break even point for the stocks position and could result in much higher gains in dollar terms, than would be the case if the position was not averaged down, in the event that stock surges in price.
When averaging down works, it's because the investor is willing to hold that stock long enough for it to bounce back. And therein lies the secret to Dollar Cost Averaging. You must have the backbone to hold on long enough for that stock to recover without losing your patience or your shirt first.
Below is an example of how dollar cost averaging could be successful when used correctly. Let us use XYZ Inc. and a purchase of 1000 of XYZ at $20 then in 2 weeks the stock falls to $10 by averaging down on XYZ by purchasing an additional 1000 shares at $10 and adding to the other 1000 shares at $20, you can bring down the breakeven point (or average price) of XYZ's position to $15 dollars:
•1000 shares xyz $(20) = $20,000
•1000 shares xyz $(10) = $10,000
•$2000 shares xyz $(15 avg) = $30,000
•1000 shares xyz $(10) = $10,000
•$2000 shares xyz $(15 avg) = $30,000
No let us pretend that now XYZ stock starts to trend higher and a few weeks later it trades at $18 per share, the investor now has a potential gain of $6000 with an average price per share of $15 on 2000 shares (despite the fact that the stock is still trading below the initial entry price of $20):
Had the investor not brought the average cost down when the stock dipped to $10, the potential loss on the position (when the stock is at 18 would be -$2000). So if you’re a novice investor new to the stock market, go ahead and try dollar cost averaging. You might have success with it!
Remember, before averaging down on any stock position, it is very important that the company as a whole and its statistics be fully assessed. A trader should make sure whether a significant decline in a stocks price is a short term miscorrelation or a symptoms of a deeper issue at hand. At the very least, many factors need to be assessed - like the company's competitive standings, future earnings outlook, financial stability, and corporate structure.
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Bear in mind, at any time you can tilt the odds of success in your favor by adding BullsToBears.com to you trading arsenal. With our trading program you can achieve the best possible results with the least amount of effort by following our stock alerts and proven trading methods. Benefit from our low-risk approach that will leave you no reason to worry. Have more time to yourself to live a more meaningful life.
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