A Practice That Will Guarantee Disaster
AVERAGING DOWN = Loosers average Loosers.
It would be bad enough to sit and watch your wealth disappear and do nothing to protect yourself by not using a STOP LOSS, but it is even worse to put more money into a losing investment. Throwing good money after bad is one of the quickest ways to the poorhouse. This is called averaging down.
Brokers often talk their clients into buying more shares of a stock that shows a loss in an effort to sell more stock or rationalize the poor recommendations they made in the first place. They tell the client that it will lower their cost basis. If you liked it at $50, you’re going to love it at $40, right? Double up at $40 and your average price is now $45. Wow, what a deal! You now own twice the amount of stock, and you’ve doubled your risk. Your loss is still the same; you didn’t gain anything except maybe a double-size loss if the stock keeps sliding. How about buying at $30, then $20, and then $10? How ridiculous! There is no shame in losing money on a stock trade, but to hold on to a loss and let it get bigger and bigger or, even worse, to buy more is amateurish and self-destructive.
High-growth stocks that fall in value after you purchase them at a correct buy point do not become more attractive; they become less attractive. The more they fall, the less attractive they are. The fact that a stock is not responding positively is a red flag that the market is ignoring the stock; perception is not going in your direction. Maybe the general market is headed into a correction or, even worse, a major bear market.
For many traders, it’s tempting to buy a pullback because you feel you’re getting a bargain compared with where the stock was trading previously. However, averaging down is for losers, plain and simple. If this is the type of advice you’re getting, I suggest you get a new broker or advisor. This is simply the worst possible advice you can receive. Remember that only losers average losers.