A:

This is a good question, and the answer has two parts. First, let's address the concept underlying the strategy to which you are referring, and then discuss the validity of this strategy.

Buying more shares at a lower price than what you previously paid is known as averaging down, or decreasing the average price at which you purchased a company's shares. For example, say you bought 100 shares of the TSJ Sports Conglomerate at $20 per share. If the stock fell to $10 and you bought another 100 shares, your average price per share would be $15. Basically, you would be decreasing the price at which you originally owned the stock by $5.

However, even though your average purchase price would've gone down, you would've had an equal loss on your original stock - a $10 decrease on 100 shares renders a total loss of $1,000. Purchasing more shares to average down the price wouldn't change that fact, so do not misinterpret averaging down as a means to magically decrease your loss.

The trick is to know when to apply averaging down. But there are no hard-and-fast rules. Basically, you must re-evaluate the company you own and determine the reasons for the fall in price. If you feel the stock has fallen because the market has overreacted to something, then buying more shares may be a good thing. Likewise, if you feel there has been no fundamental change to the company, then a lower share price may be a great opportunity to scoop up some more stock at a bargain.

It's important to realize that it is not advisable to simply buy shares of any company whose shares have just declined. Even though you are averaging down, you may still be buying into an ailing company that will continue its downslide. Sometimes the best thing to do when your company's stock has fallen is to dump the shares you already have and cut your losses.

For more info on knowing when to let go of your shares, see The Art Of Selling A Losing Position and DCA: It Gets You In At The Bottom.

RELATED FAQS
  1. How can you lose more money than you invest shorting a stock? If you have no money ...

    The simple answer to this question is that there is no limit to the amount of money you can lose in a short sale. This means ... Read Answer >>
  2. How do I figure out my cost basis on a stock investment?

    The cost basis of any investment is the original value of an asset adjusted for stock splits, dividends and capital distributions. ... Read Answer >>
  3. I have only $500 to invest, am I limited to buying only penny stocks?

    No, you are not required to invest only in penny stocks - investors are generally not restricted to a certain kind of stock ... Read Answer >>
  4. How can I profit from a decline in the telecommunications sector?

    Learn the ways savvy investors use short-selling techniques and put options to profit from declines in the telecommunications ... Read Answer >>
  5. Why would I need to know how many outstanding shares the shareholders have?

    Find out why shareholders should know how many outstanding shares have been issued by a corporation, and learn what happens ... Read Answer >>
  6. Why is purchasing stocks on margin considered more risky than traditional investing?

    Learn why purchasing stocks on margin is riskier than traditional investing, although it can be more profitable when it is ... Read Answer >>
Related Articles
  1. Investing Basics

    Investing $100 a Month in Stocks for 20 Years

    Learn how a monthly investment of just $100 can help build a future nest egg using properly diversified stocks or stock mutual funds.
  2. Investing Basics

    3 Ways To Increase Your Investment Performance

    Savvy investors deploy each of their dollars to work in more than one way. Find out how to multitask your money.
  3. Personal Finance

    Revive Your Portfolio

    Increase your annual returns by rebalancing your investments now.
  4. Active Trading Fundamentals

    Five Minute Investing: Getting Started

    If you are a beginner in the world of investing, it is natural to be a bit apprehensive about getting started investing in stocks. Even though you now have a good strategy, you may want to see ...
  5. Investing

    The Art Of Selling A Losing Position

    Knowing whether to sell or to hold is tough. And no rule fits all. Find out what to consider.
  6. Options & Futures

    Tailoring Your Investment Plan

    Start your own investing adventure with the help of some simple guidelines.
  7. Financial Advisors

    How to Protect Your Portfolio from a Market Crash

    Although market crashes are usually bad news for your portfolio, there are several ways to minimize losses or even profit outright from market movement.
  8. Options & Futures

    Fix Broken Trades With The Repair Strategy

    You can recover from your losses if you know how to use this handy trader's tool.
  9. Active Trading Fundamentals

    Five Minute Investing: Things To Avoid

    Building up the last chapter, we are now ready to explore and face the mistakes that nearly every beginning investor makes. Do not skip over this or any other part of the book because you need ...
  10. Products and Investments

    Cash vs. Stocks: How to Decide Which is Best

    Is it better to keep your money in cash or is a down market a good time to buy stocks at a lower cost?
RELATED TERMS
  1. Share Repurchase

    A program by which a company buys back its own shares from the ...
  2. Book Value Per Common Share

    Book value per common share is a measure used by owners of common ...
  3. Scale In

    The process of purchasing shares as the price decreases. To scale ...
  4. Outstanding Shares

    A company's stock currently held by all its shareholders, including ...
  5. Covered Call

    An options strategy whereby an investor holds a long position ...
  6. Cash Per Share

    A company's total cash divided by its shares outstanding. Cash ...
Hot Definitions
  1. MACD Technical Indicator

    Moving Average Convergence Divergence (or MACD) is a trend-following momentum indicator that shows the relationship between ...
  2. Over-The-Counter - OTC

    Over-The-Counter (or OTC) is a security traded in some context other than on a formal exchange such as the NYSE, TSX, AMEX, ...
  3. Quarter - Q1, Q2, Q3, Q4

    A three-month period on a financial calendar that acts as a basis for the reporting of earnings and the paying of dividends.
  4. Weighted Average Cost Of Capital - WACC

    Weighted average cost of capital (WACC) is a calculation of a firm's cost of capital in which each category of capital is ...
  5. Basis Point (BPS)

    A unit that is equal to 1/100th of 1%, and is used to denote the change in a financial instrument. The basis point is commonly ...
  6. Sharing Economy

    An economic model in which individuals are able to borrow or rent assets owned by someone else.
Trading Center