Average Down

Averaging down is the process of buying a stock at a lower price than the previous purchase. When an investor averages down, his average purchase price is lowered, making it easier to breakeven.

Suppose Joe buys 100 shares of X at $100. The stock price falls to $50. If Joe buys another 100 shares at $50, his average purchase price is now $75 on 200 shares.  Therefore the stock would only need to rise 50% for him to breakeven, instead of 100% before averaging down.

Averaging down is generally frowned upon by traders, as examples of disasterous averaging down include stocks like Enron, which went straight to zero. However, value investors believe averaging down is a good idea since you’re getting more of a good thing for a cheaper price, as long as the fundamentals of the company remain intact.

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