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Why not to average down
Feb 7, 2012
The human mind is a funny thing. Once it’s programmed to do one thing, it’s tricky for it to do anything else.
The human mind is a funny thing. Once it’s programmed to do one thing, it’s tricky for it to do anything else.
This can cause problems when your mind in trained to do something in one arena, but also finds itself doing the same thing in an environment in which this action becomes damaging.
This is a roundabout way of saying that ways of thinking that are beneficial in the real world can be damaging to your trading.
This is not a supermarket
After years of shopping at the supermarket, petrol stations, and the bottle shop, we come to associate prices with certain products. A loaf of bread is about $2.50, petrol is about $1.40 a litre, and slab of beer is about $35.
So, if bread falls to $2, the first thing you do is stock up! Buy ten loaves and put ‘em in the freezer! The same goes for petrol and, when it comes to slabs of the beer, the answer is just as obvious.
This all works fine in supermarket, but in the other super market, this strategy might send you to the poor house.
Once our brain recognises that something has an intrinsic value, whether it is that Rio Tinto is worth $150 or Commonwealth Bank is worth $60, any price lower is naturally seen a bargain.
Of course, time and time again we have learnt that a price that is falling is more likely to keep falling than bounce. But our hard-wired brain will try and trick us!
Don’t believe
This is especially true when a stock you own is falling. You’ve already stamped a price on the share – the price you paid – so anything lower is a bargain.
This produces the temptation to average down, where you continue to buy a share as it falls, because this reduces the “per unit cost” of the share. While this does reduce the “per unit cost”, it also increases your overall exposure – to a share that is going down.
This isn’t to say averaging down is necessarily a bad thing, it can have its uses, but averaging down needs to be done in the right conditions.
So, when you are thinking of averaging down, think again, and remember the tricks your brain can play.
Turn it upside down
Believe it or not, many traders believe the better strategy is to average up! This just means that when a stock you own is moving higher, you should buy more of it.
Traders usually believe that the decision of the market is law. So, if a stock is going up, that’s a sign the market thinks the stock is worth buying. And, of course, the opposite is true.
The most important part of trading, however, is to have a plan. All investors and traders should have a road map of the price at which they plan to buy stocks, when they will add to their positions, and when they should sell.
This is just one way of stopping our minds playing silly tricks on us!
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Comments
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Riski -
February 22, 2012, 8:17 pm
Add A CommentI have not heard ayhtning to that effect but yes. the US dollar had steadily lost its position of power, more so in the last 10 months or so.WHat currency will take its place? the euro is a contender