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Suppose I have bought 10 shares of a Stock 'xyz' @Rs. 100. It keeps falling in a short term but I am bullish on the stock and know that over a long term stock price will go up. I want to buy more to average down my purchase price of the stock. My question is as follows.

  1. At what percentage drop of the stock price should I buy more shares. (Ex: should I wait for the price to fall by 5% or 10% to buy more.)

  2. How many additional shares should I buy. (Ex: Initially I bought 10 shares, should I buy 5,10 or 20.)

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    "I... know that over a long term stock price will go up." You cannot think in absolutes like this. You cannot know for certain that a stock will rise, even in the long term. Be aware of the shortcomings of all future analysis, including your own, and be sure that you understand that what you are doing includes risk. By assuming in the first place that your stock will rise, you set yourself for failure by minimizing the true cost of risk inherent in any stock transaction. This line of thinking leads to the type of question you have asked here, 'how do I proceed?'. There is no guaranteed answer. – Grade 'Eh' Bacon Nov 4 '16 at 14:32
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    Note that the price is going down because a large part of the market disagrees with that assessment. – RemcoGerlich Nov 4 '16 at 15:52
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    (1) you are going to lose huge amounts of money. (2) regarding the particular theoretical number you are asking about. pick one randomly because it makes utterly no difference: you are going to lose huge amounts of money. – Fattie Nov 4 '16 at 16:56
  • Thanks a lot for your comments.I am not sure why the question was voted down. Is there a way to know why the question was voted or may be if it was mentioned in the comments it would be helpful for me to rectify it in future. – Alok Nov 4 '16 at 17:50
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TL;DR; There is no silver bullet. You have to decide how much to invest and when on your own.

Averaging down definition:

DEFINITION of 'Average Down'

The process of buying additional shares in a company at lower prices than you originally purchased. This brings the average price you've paid for all your shares down.

BREAKING DOWN 'Average Down'

Sometimes this is a good strategy, other times it's better to sell off a beaten down stock rather than buying more shares.

So let us tackle your questions:

At what percentage drop of the stock price should I buy more shares. (Ex: should I wait for the price to fall by 5% or 10% to buy more.)

It depends on the behaviour of the security and the issuer. Is it near its historical minimum? How healthy is the issuer? There is no set percentage. You can maximize your gains or your losses if the security does not rebound.

Investopedia:

The strategy is often favored by investors who have a long-term investment horizon and a contrarian approach to investing. A contrarian approach refers to a style of investing that is against, or contrary, to the prevailing investment trend.

(...)

On the other side of the coin are the investors and traders who generally have shorter-term investment horizons and view a stock decline as a portent of things to come. These investors are also likely to espouse trading in the direction of the prevailing trend, rather than against it. They may view buying into a stock decline as akin to trying to "catch a falling knife."

Your second question:

How many additional shares should I buy. (Ex: Initially I bought 10 shares, should I buy 5,10 or 20.)

That depends on your portfolio allocation before and after averaging down and your investor profile (risk apettite).

Take care when putting more money on a falling security, if your portfolio allocation shifts too much. That may expose you to risks you shouldn't be taking. You are assuming a risk for example, if the market bears down like 2008:

Averaging down or doubling up works well when the stock eventually rebounds because it has the effect of magnifying gains, but if the stock continues to decline, losses are also magnified. In such cases, the investor may rue the decision to average down rather than either exiting the position or failing to add to the initial holding.

One of the pitfalls of averaging down is when the security does not rebound, and you become too attached to be able to cut your losses and move on.

Also if you are bullish on a position, be careful not to slip the I down and add a T on said position. Invest with your head, not your heart.

  • Thanks a lot for your answer. I know the answer to my question is very subjective but still your reply helped me broaden my outlook.Thanks. – Alok Nov 4 '16 at 17:55
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A big part of the answer depends on how "beaten down" the stock is, how long it will take to recover from the drop, and your taste for risk.

If you honestly believe the drop is a temporary aberration then averaging down can be a good strategy to lower your dollar-cost average in the stock. But this is a huge risk if you're wrong, because now you're going to magnify your losses by piling on more stock that isn't going anywhere to the shares you already own at a higher cost.

As @Mindwin pointed out correctly, the problem for most investors following an "average down" strategy is that it makes them much less likely to cut their losses when the stock doesn't recover. They basically become "married" to the stock because they've actualized their belief the stock will bounce back when maybe it never will or worse, drops even more.

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Only average down super blue chips with a long history or better still, ETFs or index type funds. I do it with income producing funds as I'm a retiree. Other people may have much shorter horizins.

  • This requires a detailed explanation. Why should they not average down given that they "know" it'll go up in the long term? If you have certain knowledge a stock will go up, it would seem rational to buy as much as you can afford before it does so. – ChrisInEdmonton Apr 7 '17 at 14:24

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