Averaging In Stock Market: As we enter the new year, all we see are offers from everywhere. It could be your favourite sneaker brand, the latest smartphone or a brand-new bike.
We have a unique experience when we make purchases at once-in-a-lifetime prices. Ideally, everything on offer and getting more for a less price would be a great deal.
Now imagine getting the best prices on your favourite stocks, despite investing at all-time highs. As impossible as that sounds, this investing strategy can get you the best prices for your favourite stocks – Averaging in stock market.
We’re going to explain how averaging in stock market works, and how investors can get the best fair price for their stocks, irrespective of the volatility in the markets.
What Is Averaging In Stock Market?
You might have come across the line – timing the markets. It essentially means waiting for the right time to enter the markets to increase your gains and reduce the chances of losses.
While this might work out in the short term, it could also take away opportunities in the long term. Averaging in the stock market gives a realistic solution to investing in stocks at a fair price or average price.
Averaging is a stock market strategy of increasing or decreasing your average share price to tame market volatility in your portfolio. Volatility is what moves the market, but it could work for or against you.
This means while price fluctuations with stocks are normal, they could either leave you with wider losses or greater gains. So how does averaging in stock market work?
Below, we’re going to list some of the well-known averaging strategies used in the markets. So let’s get started!
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Averaging In Stock Market – Strategies
In the introduction, we wrote about buying stocks at the best prices. Waiting for a stock to hit the ideal buy price could be an expensive investment decision that’ll cost you in the long run.
This is why we use averaging in stock market, especially for long-term capital gains. One of the most common mistakes investors make is buying stocks at their all-time highs.
While the company might be fundamentally strong, it is uncertain as to exactly in which direction the stock will move after reaching its all-time high. Here are some of the key averaging strategies stock market.
1. Averaging Up
Picture this scenario – The markets are in a bullish trend and the indices are regularly climbing. With the averaging up strategy, an investor can invest in shares if the climbing trend continues with the market.
Assume an investor Finn buys the stock Alpha because he has a bullish approach to it. He buys 100 shares for ₹1950 rupees per share.
After a few weeks, the stock price climbs from Finn’s buy price. After seeing the movement, he is stronger with his bullish approach and buys more shares for ₹2300 rupees per share.
Notice that Finn could have sold his holdings and booked a decent profit. But, since he is convinced that the stock price will climb further, he makes another purchase.
Here, Finn has averaged up his position by buying more at each climbing interval. His average price will still be lower than that of the current market price due to investing at different price points over time.
2. Averaging Down
Averaging down is a well-known stock market strategy. Here, investors buy more shares as their company share price decreases to average out their holdings and minimise losses.
This is after the initial investment in the same stock. Here you would be buying more shares for a lower price so that the overall price of your stock in your portfolio is lowered. Take a look at the example below to understand it better –
Two investors Finn and Grad are bullish on a stock Beta. They also have a similar profit target price of Beta as ₹1,000. Finn invests about ₹1,00,000 into Beta at a point in time T.
While Grad was also bullish on the stock, he doesn’t invest it all at once. After a thorough analysis, he decides to invest ₹50,000 at a point in time T, and after the stock price drops to a certain level, say ₹900 per share, he decides to invest the remaining ₹50,000.
Both investors have invested the same amount of money but Grad has an average price lower than Finn, because of the difference in investment points.
Finn has to wait for Beta to reach ₹1,000 to break even whereas Grad has to wait till the stock price reaches ₹947 rupees per share. Additionally, Grad now owns more shares due to the price drop in the stock price of Beta.
3. Systematic Investment Plan (SIP)
SIPs are the most popular form of averaging in stock market. Here, irrespective of the dips and gains of stock, you set aside a fixed amount of money to purchase stocks on a regular basis.
It is most commonly used in mutual fund investing. Investors invest a fixed amount of money every month and based on the market prices, are allocated units to their portfolio.
This is a form of auto averaging as it doesn’t require active involvement in buying shares or units regularly.
4. Imprudent Averaging
We’ve all done this enough times till we learnt our lesson – Buying stocks based on popularity, hype and recommendations.
Due to the commotion in the market, the stock price climbs to a high price and after the hype goes away, the share price of the company tanks.
Sometimes to the point of becoming a penny stock like Vodafone Idea or Yes Bank. Here is where most investors are confused about whether to exit and accept their losses or average out by buying more.
In such scenarios, averaging out can cause more harm than good. By regularly investing in what has essentially become a penny stock, you might get more shares for a very inexpensive price.
But the true cost of doing this is ending up with a fundamentally weak stock for a long time.
Here, you also face opportunity costs, where the bad investment has caused you losses, and side by side, taken away the opportunity of investing your money elsewhere.
Here averaging is illogical because of the stock held, which takes away valuable capital and time from your investment goals.
Also Read: Can I Earn 1 Crore From Stock Market? Everything You Need to Know!
In Closing
With imprudent averaging, we have reached the end of this blog on averaging in stock market. As you can see, there are multiple types and strategies of averaging in stock market but they are only as good as the stocks you hold.
It doesn’t help your portfolio if you average out your stock price by holding fundamentally weak stocks, because of their affordability.
Remember Warren Buffett’s advice – “Rule #1 is never losing money. Rule #2 is never to forget Rule #1.” Happy Investing!
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