DEFINITION of Average Down
Average down or "averaging down" is a slang term describing the process of buying additional shares in a company at lower prices than the original purchase price. This brings the average price you've paid for all your shares down.
BREAKING DOWN Average Down
Although averaging down offers the appearance of a strategy; it's more a state of mind than a legitimate investment strategy. In theory, if an investor liked a stock at $35 per share, and the stock priced dropped, but the investor still thought the stock was attractive at $35, then purchasing more shares at a depressed price offers the appearance of a discount. While there may be unrecognized intrinsic value, buying additional shares simply to lower an average cost of ownership is not a good reason to purchase a stock as its price falls.
Averaging down does allow investors to lower their cost basis in a stock position, which can work to limit future capital gains. However, if a stock continues to fall, capital losses will only mount further.
Proponents of the technique view averaging down as a cost-effective approach to wealth accumulation; opponents view it as a recipe for disaster.
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. Here again, averaging down can be thought of something of a rule of thumb: buy when there's blood in the streets.
Interestingly, over the years some of the world's most astute investors, including Warren Buffett, have successfully used the averaging down strategy over the years. Which further gives the illusion of this technique as an investment strategy. However, investors like Buffett may purchase additional shares of a company because they feel the stock is underpriced, not because they want to "average down."