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Dear Readers,
AVERAGING DOWN
By Daryl Guppy
SUBJECT SUMMARY
AVERAGING DOWN
This is usually called a losers strategy. Investors are encouraged to buy more shares when prices fall because they are cheaper.
This thinking is also part of the popular Dollar Cost Averaging strategy which is very dependent upon exact timing for success.
The averaging down strategy has an appealing logic. If we buy 10,000 shares at $1.00 each we spent $10,000. In this trade our
breakeven point is $1.00, and perhaps our profit target is $1.10 for a 10% return. Prices fall to $0.50. If we buy at this level we increase
our position size for a lower cost and we also lower the breakeven point. If we spend an additional $5,000 we get 10,000 shares.
Our total shareholding is now 20,000 shares for a cost of $15,000. The average cost of our shares falls to a breakeven point $0.75.
The strategy works only if prices rebound and in a bear market this is a low probability outcome.
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The continuing disaster in Japan will drag down world markets. It will impact heavily on particular industries and commodities.
Traders must make a decision about selling, holding, or using averaging down methods to trade back into the inevitable rally.
These notes explore the issues around averaging down. They use old chart examples, but the lessons and the calculations remain valid in today's environment. Editor.
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Martin Wong
Trading Coach
Investmatic Management, SoHo, Ara Damansara, Selangor DE, Petaling Jaya 47301, Malaysia
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