If you are new to investing in stocks, it may seem like every stock goes down right after you purchase it. This can lead to short-term frustration, but you be able to use that decline to your advantage. If you buy more shares of a stock after the price falls, your total average cost for that stock will go down in a process known as "averaging down." Essentially, it means the stock doesn't have to go back up as far for you to make money.
Record the original purchase price for your stock. You can only average down on your stock if the price falls.
Read the press releases a company puts out to help determine what made the stock go down. Listen to financial news programs on television for additional information and discuss it with your broker. If a stock falls in price due to problems with management or the failure of a product, averaging down may only compound your problem. If the stock went down along with the stock market as a whole, the problem may just be the daily volatility of the stock market. If the company is still making sales and growing its profits, those are solid fundamentals. In that case, averaging down may be a good strategy for you.
Buy more of the same stock when the price goes down. Typically, averaging down on a stock involves buying the same amount you originally purchased. For example, if you bought 100 shares of stock XYZ at $50 per share, you would buy an additional 100 shares at a lower price, such as $40 per share. Your average cost in this situation is $45 per share. However, as long as you buy some amount of the same stock at a lower price, your average cost will drop.
Track all purchases and sales for tax purposes. When you sell your stock, you must list each purchase you made and the price you received on your taxes. Although you effectively lowered your average stock price, the Internal Revenue Service does not recognize "averaging down." When you sell the stock, you will show a separate gain or loss for each individual purchase you made. For example, if you bought the same amount of a stock twice, at $50 and $38, and sold all of it at $45, you will show a loss of $5 per share on the first lot, and a gain of $7 per share on the second lot. From a purely financial perspective, averaging down has transformed your $5 per share loss to a net gain of $2 per share.
- While averaging down can be a successful strategy if a stock rebounds, you could lose twice as much money if the stock never turns around. Many advisers caution against averaging down unless prospects for a stock rebound are high, and the reason for the original decline was irrational.
- Hemera Technologies/AbleStock.com/Getty Images