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View Full Version : MY SOLUTION TO AVERAGING DOWN



whiteheron
02-12-2004, 09:54 PM
When I started share trading about 2.5 years ago I had convinced myself that averaging down could get you out of trouble if a share you had purchased fell in price , on the belief that things would correct and you would soon be back in the money
HOW WRONG I WAS , all I did (by averaging down 3 to 5 times ) was dig myself into a deeper and deeper hole from which I could not extricate myself
Additionally , I was not at that stage using stop losses --- all in all definitely not a good look that led to several catastrophic losses

The above scenario is , I believe , not uncommon with those new to the game and it is they that I direct my comments to (those that have suffered the expensive knocks will know what I am talking about and will have their own particular techniques sorted )

My solution , learned the hard way , is to allow myself only one purchase at a lesser price than my first one and then only after having re satisfied myself that the particular share is underpriced and still a good buy
Stop loss orders should also be placed to protect against those price collapses that can and sometimes do occur
If I cannot satisfy myself that a second purchase is warranted then I take an early exit at a relatively small loss and move on to greener pastures

From my experience you do not need to make up your losses on the same shares as you incurred them on --- it is much better to move on and look for new opportunities of which there are always some , maybe a bit hard to find but they are always there
It is unquestionably much more rewarding and profitable to chase winners rather than losers

I will be interested in hearing from others who have successfully adopted a different strategy to me , I do not claim mine to be the only one --- it just happens to work pretty well for me

duncan macgregor
03-12-2004, 07:13 AM
WHITEHERON, I never buy more if it drops. It hits my predetermined stop loss, then i get out right or wrong. Work out the mathematical chances of you being wrong, or the market against the chance of you being wrong starting from scratch. Lets suppose one in five goes nowhere or drops from a fresh start, against a fifty fifty chance of being right averaging down. The point really is not letting your pride get in the way of making the market work for you.
It is only the fundamental investors that will average down, with the I am right attitude, that ends up costing them big.
Its up to each their own i suppose, thats how i do it right, and sometimes wrong. MACDUNK

Halebop
03-12-2004, 09:07 AM
Well all rules are made to be broken. I learned the rule never average down before I knew why? Over the years I've probably broken it 20 or more times. Although there were ocassions where I certainly have lost more money as a result, overall I benefited around 75% of the time.

This situation doesn't happen very often now because I pay more attention to trends on the charts but I'm sure it won't be the last time I average down.

Disclosure: I'm not advocating averaging down, it is still my exception rather than the rule. I just think dogmatism is for faith, religion and left/right wing think-tanks, not investing.

stephen
03-12-2004, 09:58 AM
I agree, Halebop.

The thing is, for a fundamentalist, it is not "averaging down". It is buying in at an even better price. "Averaging down" comes from a conceptual world where prices have a life of their own, and value investors don't live in that world.

Having said, that, each later purchase of a share should have at least the same amount of spadework preceding as the earlier purchases. The "belief that things will correct" must be founded in a rigourous reevaluation - when things drop, maybe other people know something you don't. (ASX.ION being a rueful case in point for me).

macdunk, you have inspired me to write more monte carlo simulators. Watch this space.

whiteheron
03-12-2004, 01:48 PM
Thanks for the interesting replies folks

Macdunk , my one allowed average down is not about pride but about attempting to get the best outcome from a trade --- my pride was shattered many moons ago and I am happy to say no longer features in my investment decisions

Halebop and Stephen , valuable comments --- yes , rules are made to be broken but only on very rare occasions
On reflection , the terminology "averaging down " is now probably a bit of a misnomer in my case
" buying at a better price " is probably a more accurate description

One important point to remember is that nothing is static in this game , every day brings changes and new challenges and these must be evaluated and taken into account if we are to succeed and profit

Lawso
03-12-2004, 03:43 PM
Never say 'never'. As a case in point, if I had never averaged down, I wouldn't have been building up my stake in TEL in '01 to '03 at under $5, having paid over $8 a year or so earlier. I much prefer the words 'buying at a better price', provided you've done some homework on the stock.

Cooper
03-12-2004, 10:05 PM
I agree with the sentiments already expressed... at any point a share should be either a buy or a sell... if it's a buy, but you happen to have already bought at a higher price, then it's still a buy (subject to weighting).
Can result in the ocassional bout of cursing, admittedly...

Risk
04-12-2004, 08:26 AM
The only time I buy more at a lower price ("average down"), is when I decided that before my initial purchase.

eg, say I decided to buy company XXX as its come onto my radar. The current price might be 45, and I might see support at 41 and a target of 60.
so I decide to buy and have a stop of 40.

Now I have several options:
1)I could buy all I want immediately at market 45-46
2)I could put in an order at 43 and hopefully it will fill in a few days.
3)I could buy some now at 45-46, and "average down" at 41 or whatever with the rest. That way I dont miss the boat completely if it keeps going up, and I still keep to the technical stop loss level, and have a better average price if it does retrace a bit.

which method I use depends on the share in question, overall market conditions, funds available etc.

kura
05-12-2004, 09:56 PM
Sorry, but I must be missing something here, an entire topic with no mudslinging yet ??

PS: Think I agree with all of comments so far myself !

Regards "Bottom Pickers" and "Averaging Down" I would refer to my purchase on ASX of some HDR shares on Friday @ 1.57 , chartwise it looks really ugly, but the fundamentalist in me says it is a screaming buy, must admit it isn't easy being a schizophrenic share trader !

Cheers All

Snoopy
12-12-2004, 09:46 PM
quote:Originally posted by whiteheron

When I started share trading about 2.5 years ago I had convinced myself that averaging down could get you out of trouble if a share you had purchased fell in price , on the belief that things would correct and you would soon be back in the money
HOW WRONG I WAS , all I did (by averaging down 3 to 5 times ) was dig myself into a deeper and deeper hole from which I could not extricate myself
Additionally , I was not at that stage using stop losses --- all in all definitely not a good look that led to several catastrophic losses

My solution , learned the hard way , is to allow myself only one purchase at a lesser price than my first one and then only after having re satisfied myself that the particular share is underpriced and still a good buy


For me there is no such thing as 'averaging down', only 'averaging across'. So I guess I am in Stephen's camp. Rather than get all theoretical, I'll put what I have to say in the context of my 'poorest' investment of the last couple of years, the Warehouse.

Did I say 'poorest'? Well that is really a 'with hindsight' term. I bought my current holding in two tranches with an average entry price of some $4.30. I was bottom fishing, or so I thought. I did some calculations that showed that if they could recover the Australian situation in a year I would likely get a compounding annual rate of return of 15% over the next ten years. By my calculations that made WHS easily the cheapest share on the NZ market if I bought it in the low $4 band. So do I regret buying into WHS at $4.30? Not at all because we can only buy with the information that is available at the time of purchase. And my research was very thorough.

The scenario has now changed , and it is possible that WHS will have trouble in Australia 'forever'. That means whether I should buy or sell WHS at $3.55 depends on how the fundamentals stack up against my new scenario of continuing to do well in NZ but barely breaking even in Australia. If the investment makes sense on those new terms I will go ahead with it. It is very important that my old scenario has no weight at all in my new investment decision. Everything in the old scenario must be wiped from my memory. It must have nil/nada/ no effect at all on my new investment decision.

Put like that Whiteheron, your rule of thumb that allows you to average down once makes no sense. What you are saying is that because a previous manager had a failed grandiose plan and was sacked, which called the share price to fall, you should judge the new manager on the previous fellow's 'success', even though the new management plan is completely different.

You didn't mention specific examples Whiteheron, but my gut feeling about your early forays in the sharemarket is that your F/A simply wasn't good enough. The mere fact you employ stop losses suggests to me that you had little confidence in your initial decisions and put more faith in what some ignoramus at the golf club told you, rather than your own work.

SNOOPY

PS Basically I am saying there is no 'rule of thumb'. You have to analyze each situation as a new situation in its own right.

duncan macgregor
13-12-2004, 07:15 PM
SNOOPY, I look on it as being the one big flaw in a fundamentalist share strategy. Without a stop loss at a predetermined level a investor risks losing all their good gains with one bad investment.
In a perfect world where everything is foreseeable yes. We are not told the truth companies make decisions behind closed doors all sorts of greed and corruption with inside trading etc etc. To convince yourself you are right is the wrong thing to do. We are never 100pc sure so therefore it pays to have systems in place with the odd one that goes bad. Throw the bad apple out the box before it rots the others. cheers macdunk

Westie
15-12-2004, 01:34 PM
MacDunk
IMHO setting a stop loss at a predetermined level is effectively saying the market is right no matter what i.e. the market is efficient. If the market is efficient, then there is no point having any buy/sell strategy whatsoever, stock performance is random.

If the market is not efficient, then setting a predetermined stop loss is a less than desireable strategy as a price drop represents an opportunity to assess whether the market is right and something fundamental has changed about your investment, or the market is wrong and is offering your an even better bargain. Mechanically selling is passing up the potential to better your returns

duncan macgregor
15-12-2004, 02:38 PM
WESTIE, You are wrong with what i said. The market is what proves you right or wrong. Nobody is right 100pc all the time, there are to many unexpected things to go wrong, to many lies you listened to, and to much going on behind the scenes that you and i are oblivious off.
To have a system that says you are right, and the market will find out, and play catch up in my own experience works out four out of five. In my case the fith one, or the bad apple either goes nowhere or drops in price. It is the same thing your money is not working or is going down. When your money stops working or goes down it pulls the others down with it like a bad apple in a box. It is only common sense to realise to take a small calculated loss on the one apple, and buy another apple, rather than bleat on about how good the apple is and watch it rot the others. It is mr market that decides the winners and losers, and mr market is a complete lunatic.
In my own case i buy in a 50pc holding of my intended lot in a company if it drops 5pc im gone if i am proved right i buy the other 50pc holding with a predetermined stop loss to suit the company. I normally buy in lots to suit brokers fees. My other completely seperate way of trading is spec buying and selling, which i do for a bit of fun as with buying and selling nog and others.
In other words WESTIE the answer to successfull investing means dont let a little mistake turn into a big mistake. macdunk

whiteheron
15-12-2004, 05:45 PM
macdunk

I am pretty much in agreement with what you say on this issue

The way I look at it is that the market is not necessarily right or wrong , BUT IT IS KING
Whatever the market says is it , no ifs , no buts , no maybies --- an individual investor can argue all he likes , and his arguments may well be very logical and valid , but if THE KING says otherwise then that is it and there is not a dammed thing that an individual investor can do

On the positive side however this is what creates opportunities , especially for those of us who trade frequently (I have been trading several times a day recently )

One has to try to read the market better than most others (not always easy , but very rewarding when it all goes to what you assess and predict )

My aim is to get it right about 4 out of 5 times , difficult but sometimes achievable
It is most important to limit your loss on the ones that dont go your way --- if you dont do this the one bad trade will invariably wipe out all of your gains on the other 4 or so trades

Cut losses ruthlessly before they become serious (use stop losses ) and follow winners rather than losers

Westie
16-12-2004, 08:29 AM
Yes, the market will prove you wrong or right, but only with the addition of time.

“In the short-term the stock market is a voting machine; in the long-term it’s a weighing machine.”

Benjamin Graham

Mechanically selling the moment a price drop occurs without taking into account the human foibles of fear and greed that grip the market from time to time will eliminate one of an intelligent investors greatest assets, the ability to think for oneself and not follow the herd.

The only way to beat the market is to exploit other investors' mistakes.
-- Charles D. Ellis

At any rate, it appears that timeframe is the key difference between those that see a price decline as an opportunity vs those that see it as a signal to sell.

It is of course wise to tailor your strategies to your investing style.

whiteheron
16-12-2004, 10:19 AM
Thanks folks for your valuable and thought provoking comments --- much appreciated
I have gained some most useful pointers from our discussions

One point that nobody has mentioned , myself included , is averaging down on winning situations and it is here that on occasions I have had considerable success

Taking LAF.AX as an example I originally purched several parcels of these at between 9c and 11c
When the price increased to about 12.5c I sold about 50 % , later buying back at about 11c
Again I sold at about 14.5c to later buy back at about 12c and I have continued this process through to the present , with the result that I now have a nice sum invested in LAF at a really excellent average price and I consider that there is still considerable upside in this company

If you have satisfied yourself that a company has bright medium to long term prospects together with a volatile share price then I consider that the averaging down on a winning situation can be very profitable , but it does require some committment and fortitude
LAF was an example of this , a company with excellent prospects but country risk (now not applicable as a result of the recent Singapore Supreme Court decision ) the perceived country risk probably adding considerably to the volatility

All in all , I consider that averaging down on a winning situation to be a much better bet than so called averaging down on a losing situation

I have come to the conclusion that it is more profitable ( and fun ) to follow winners rather than losers
Having said that , I still buy at a better price if circumstances warrant ( after re satisfying myself about a company and its future prospects )

The terminology "averaging down " on a losing situation has been removed from my vocabulary as it can give a misleading impression

Any other thoughts / comments on this will be appreciated

Good investing

Lawso
16-12-2004, 10:44 AM
quote: I normally buy in lots to suit brokers fees.
What does that mean, macdunk? That you buy sufficient to get a reduced rate of brokerage, or to avoid a broker's minimum fee?
I'm accustomed to paying 1% brokerage on virtually every transaction, always buying enough to ensure I avoid a minimum fee. I only trade by phone, btw, never on the net.

duncan macgregor
16-12-2004, 10:48 AM
WESTIE, you mention fear and greed, you might include panic in that lot. The market over reacts going up, and going down, making great trading opportunities for the smart investor. The price in a good company will get pushed to high [everybody loves a winner]. the smart investor gets out, and the sp will drop or go sideways for a while then surge up again. MHI is a perfect example of this it is going sideways right now. When a share drops in price it normally drops gaining speed as it goes triggering stop losses on the way down. The people left holding the baby are the fundamentalists that are convinced they are right, and the market is wrong. That to me is stupid we are trading to make money if a share is going down get out and buy into something trending up. macdunk

Lawso
17-12-2004, 12:59 PM
All right then, don't answer my question. See if I care, you ill-mannered Scottish g*t.

J J (just joking) ;)

Snoopy
17-12-2004, 01:34 PM
quote:Originally posted by duncan macgregor

SNOOPY, I look on it as being the one big flaw in a fundamentalist share strategy. Without a stop loss at a predetermined level a investor risks losing all their good gains with one bad investment.


I have been thinking about what you are saying here Macdunk. Actually I do have a 'stop loss' in place for all my buys. But it is not one determined by Mr Market. After all short term, as you said yourself, Mr Market is a lunatic. So determining a 'stop loss' is much too important a job to give to someone like that.

My stop loss is based on the fundamentals of what I could lose, given the worst scenario. A company that makes no money is an obvious warning sign. But if a company is risky I look to other indicators like where the share price sits in relation to the asset backing. And what would be the minimum time the company could repay all its debt, if it diverted all its profits to doing so. I also look at comparative statistics like 'market capitalisation to sales' or 'sustainable earnings yield' (for example) to see how cheap the company is relative to other companies out there.

I use gauges like these to determine where the floor may lie in relation to where the share price is now. I will only buy if the amount I lose should things turn to custard be limited. Mr Market may determine some of the benchmarks I use over time. But as to his day to day ravings, well, I prefer to ignore those when setting up my purchase and associated 'stop loss'.


quote:
In a perfect world where everything is foreseeable yes. We are not told the truth companies make decisions behind closed doors all sorts of greed and corruption with inside trading etc etc. To convince yourself you are right is the wrong thing to do. We are never 100pc sure so therefore it pays to have systems in place with the odd one that goes bad. Throw the bad apple out the box before it rots the others.


Your analogy is a bad one (sic). Even a bad apple eventually becomes compost. Put enough of them together and eventually you will have a saleable bag of compost.

Even Ron Brierley is on record as saying that in many ways knowing where to seek out a bargain is easier now than in his heyday, because so much of the company information you seek is now on line. There aren't nearly as many 'secrets' out there as the conspiracy theorists think. The main block to obtaining useful information is laziness, or the ability to read beyiond the most superficial headline.

Even a bag of bad apples can be a bargain if you don't pay too much for it. Buying at a price below ultimate market value is the key.

SNOOPY

duncan macgregor
17-12-2004, 01:37 PM
Sorry lawso, I did reply and pressed the wrong button. ASB securities rates up to$50000 .7pc min of $24-95 whichever is higher. over $50000 negotiate.Hope that helps. macdunk

duncan macgregor
17-12-2004, 02:26 PM
Snoopy we might argue the point for ever, thats what makes the market interesting. The top fifty went up 22pc in the last 11 months, or 2pc a month on average. It has been a bull market,so to hold shares that only beat the bank is ridiculous. The time to beat the bank, and worry about dividends, is when the market turns the other way. Make hay while the sun shines, and have your stop losses in place to sell to the fundamentalists, that think they are right,and the market is wrong. When it all turns round, and it will dont ride the market down making excuses, get out and rethink. cheers macdunk

Lawso
17-12-2004, 07:09 PM
Thanks, dunc. As I said, I'm used to paying 1%. Most of my transactions are in the $5k-$20k range and I'm not a frequent trader - maybe buy/sell once or twice a month. But I might try for a better deal on my next substantial order. After all, I seldom if ever ask for their advice and use them basically as order takers.

Any others care to comment on their brokerage/commissions experiences?

Halebop
17-12-2004, 07:35 PM
I have a longstanding relationship with an individual at a Brisbane based full service broker and so suffer the consequences of their rates. However, although they have the bulk of my business it is very infrequently that this stuff gets traded. On a couple of occasions there have been years between trades. They had a busy time recently because I'm largely cashed up right now.

I have two online accounts as well, one in NZ and one in Australia. Both are more actively used. My ASB Securities account charges between NZ$29.45 and A$24.95 per trade. This is often conducted in or near multiples of $30,000 so the brokerage rates work out very low - around 0.083 to 0.1%. For trading activities this is most suitable and brokerage becomes irrelevant to any of my calculations.