Averaging down is a strategy whereby investors buy shares in a company and then purchase additional shares if the share price drops. Some investors feel comfortable with this strategy, as it this lowers the average purchase price and also lowers the breakeven point for a stock position. 

If all goes well and the stock rebounds, investors may be able to secure higher returns than would have been the case if the investor did not average down. So a declining stock is surely a bargain because it is cheaper than it was a few months ago, or is it?

Do falling prices present buying opportunities?


In The Intelligent Investor, Benjamin Graham insisted that investors should see downturns as a chance to buy stocks at discount prices. It was in this spirit that Walter Schloss, who studied under Benjamin Graham before running his own investment firm, said that ‘we like to buy stocks which we feel are undervalued and then we have to have the guts to buy more when they go down.’  So the legends seem to find value investing and averaging down compatible.


Schloss was not the only guru who tried to take advantage of falling prices. Ex-Fidelity fund manager, Peter Lynch, believes that falling prices present investors with a buying opportunity, so long as the company has good long-term prospects. In One Up on Wall Street, Lynch argues that investors should identify ‘a price drop as an opportunity to load up on bargains from amongst your worst performers’. He added that ‘price drop in a good stock is only a tragedy if you sell at that price and never buy more.’

What are the disadvantages of averaging down?


But averaging down goes against momentum...


The big hope implicit in averaging down is that the stock price will eventually rise - but unfortunately for those taking Schloss’s advice - it’s more likely that in the short term they won’t.  Buying shares falling in price is a strategy that goes against the momentum effect - the tendency for prices to continue trending in the same direction for periods of three to twelve months.  It may sound bizarre, but rising shares tend to keep rising, while falling shares tend to keep falling.


In this interesting  video,…

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