Quick example: You buy shares of Stock X at $20. The stock goes down to $10. In order to try and limit your risk and losses, you buy the same amount of shares of Stock X at $10. Now your shares of Stock X is $15.

As you can see from the example above, you essentially bought more shares of Stock X to try and hedge your losses. While it is a common practice, many traders have various opinions on whether is a good or bad thing to do.

By obviously look at the end picture, we can come to conclusions. Yeah, if Stock X makes it way to $30, then averaging down was a great thing to do. What if it went down to $5? Because you wanted to average down, now you invested more capital into a still sinking stock. Are you going to average down again? What if Stock X goes to $3?

You can see that there are two distinct outcomes of averaging down. The positive and the negative. The debate about averaging down is when do you consider the trade a loss and get out?

When you initially bought your second round of shares at $10 you instantly added more capital into that holding. That is cash that can’t do anything. Yeah, if it goes up good, but what if it continues to go down? Will you sell, average down again, or just hold?

If you sell, now you incur the losses from both rounds of shares. If you average down again you are now taking on more risk. Think of it like a bet. You lost the first time, so you now offer double or nothing. Lost again, so now you offer triple or nothing. When will you consider enough is enough? Finally, what if you decide to hold? With your first attempt at averaging down, you put more money into the stock because you felt it would go up. When will you consider the trade a bust?

Kind of bringing this back to the debate, whether this is a good or bad idea? It really depends on your strategy? Are you investing in the company or just playing the stock game?

If you are investing in the company, then you did your research and have a good feeling of what should happen with the stock.

If you are just playing the stock game and feel the stock should go up higher sometime, then why waste time. Minimize your losses, get out, and move on to the next stock.

What do you think about averaging down?