What Is Adding to a Loser?
Adding to a loser is a term that refers to an instance in which a trader or investor increases their position in an asset when its price is moving in the opposite direction of their original purchase. They are adding more funds, or increasing their position size, in a losing position.
- Increasing the position size in a losing trade is called adding to a loser.
- Adding to a loser improves the average cost of the trade, but also increases the risk since more funds have been put at risk.
- Adding to a loser is not recommended by many professionals, unless it is part of a well-constructed investment or trading plan with specific rules for managing risk.
Understanding Adding to a Loser
Adding to a loser refers to situations in which an individual invests more in an asset, even though that asset is performing opposite to the investor's wishes. There can be both pros and cons to adding to a loser.
Some investment advisors may encourage the practice, calling it "averaging down," and this may be acceptable for a long-term investor with a long time horizon for their investments. Adding to a losing trade, at a better price than the original entry, will bring down the average entry price. If the price eventually reverses, the gain may be bigger than it would have been if only the initial position was taken.
Adding to a loser should only be done if it is part of an investment plan or trading plan. It should never be done simply to avoid having to take a loss. Losses are a part of trading and investing, and sometimes it is better to get out and take a small loss instead of doubling down and risking a big loss.
It is possible that an asset's price keeps moving in the wrong direction relative to the investor's wishes. In this case, the investor faces increasing losses by adding to the losing position.
Why Traders Add to Losing Positions
There are several reasons an investor may add to losing positions. The most common one is an emotional response, in which an investor might add to a losing position instead of closing it because they get emotionally attached to the asset and have a hard time accepting that it was a bad investment.
Also, asset prices are always fluctuating, and it is hard to pinpoint the perfect entry. If a stock declines initially after purchase, an investor may feel a compulsion to buy more at the lower price, feeling regret for having bought at a higher price. They want to "take advantage" of the lower price.
In all cases, once an investment moves in the wrong direction, it is important to reevaluate the reason for having the position. Is still worth holding? Is adding more funds a prudent play? Should it be sold? Professional traders and investors lay out the answers to these questions in advance. They have strategies which include buy and sell rules laid out in their trading plan.
Adding to a loser may be part of such a plan. For example, an investor may buy additional stock each month as part of their portfolio contributions. They do this regardless of the price of the stocks. In this case, they may not only be adding to losers, but also adding to winners or pyramiding.
Real-World Example of Adding to a Loser
After rallying through the first part of 2018, Macy's, Inc. (M) began another decline after reaching just over $36. Assume an investor noticed the prior uptrend and waited for a pullback, buying 100 shares of stock at $32 in September 2018. The investor views this as a long-term hold. The trade costs $3,200.
By September of 2019, the price has traded below $16. The value of the position is half of the original value of the position. The position is now worth $1,600.
The investor decides the stock is a bargain at $16, and so they increase their position, buying another 100 shares at $16. This costs an additional $1,600.
The average price is now $24. If the stock prices rallies above $24, the investor will be in the money even though they originally bought at $32. Their risk has increased, though. Before, they were risking $3,200, now they are risking $4,800 ($3,200 + $1,600). If the stock continues to decline below $16 they are losing on 200 shares, not just 100.
By March of 2020, Macy's traded below $7 as coronavirus fears sent stock prices tumbling. The investor's position is now worth $1,400 ($7 x 200 shares). So far the investor has lost 71% of their investment (($4,800 - $1,400) / $4,800). In this case, even if the stock doubles from $7 (to $14), the investor would still be underwater on their purchase at $16, and way underwater on their purchase at $32.
If the stock had rallied higher after buying at $16, each dollar the stock rises offsets part of the losses from buying at $32. The breakeven point is $24. If the price rises above $32, the investor is making money on 200 shares as opposed to only the 100 they originally purchased.