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?

When somebody conducts a great trade usually the first thing they want to do is invest more money into the project. After all if I can make so much with this amount, then I could easily double the returns with more money, right?

If you made 40% returns with $5000, then imagine what you could do with 20,30, no $60,000. Its a win-win situation, right?

By now you probably already realized I was just baiting you into an obvious corner. Just because you are lethal with $5000, that doesn’t mean you can duplicate that success with more capital. Here’s why:

Lack of Good Plays

Simply put with less money you can only have so many positions at once. Where as you could easily find 3-4 good stocks in to invest in, you may have trouble finding many stocks at one time. If you do not already have a solid system, scan, or whatever it is you do to find stocks, then it can be hard to make good use of all the money and end up in the red.

Often times, that is why many high profiled brokers or funds don’t see high returns so often. With all the money they have to manage, they merely don’t have the man power to physically hand pick each stock. Rather they have scans created that picks stocks that fits their criteria.

Just like in any business. The larger it gets the more it seems like you need to automate or outsource.

The Ability to Maintain High Pain Threshold

By this I mean you need to make sure you don’t get scared at the first sign of loss. In the $5000 example, making $200 may have seemed like a great day and losing $100 was probably no big deal. What happens when you lose that same percentage with $60000 of capital, which equals $1200.

Will you get scared, frustrated, stressed out?

Some do, and that causes them to make bad decisions, which ends up making the situation even that much worse. Do you have what it takes to not get squeamish when you lose so much of your OWN money in one day?

On the flip side, can you maintain not getting too excited when you make $1200 in one day and let your guard down?

Disorganized and Lack of Plan

Along with more money comes the need to have a clear and more focused plan. Like I stated before, with less money you hold less stocks. This means that you could probably remember many of the buy and sell points on the top of your head.

With more money, that may not be the case. That is why its important to have a solid game plan. You should record everything you want to buy, sell, when to do it, and problems that you encountered. The last thing you want to happen is have your stock plunge because your forgot the sell point.

This will save you time when it comes to taxes and actually help with the ability to add even more money to your account.

Final Thoughts

Now I am not saying that you can’t be successful with more money; however, you should plan and be cautious before throwing the boat into the equation. The more money you add into your portfolio, the more you should treat it like a true business. If an actual company had no plan, then they probably wouldn’t grow in the long run, and either will your portfolio.

Like Diddy said, “more money you come across, the more problem we see.”

image source – discoveryconsulting.com | This article is based on TWI article from May 18, 2008