What Does The Term Average Down Mean In Trading?
The term averaging down in stock trading is the act of buying more shares to improve your price. Lets say you bought 100 shares of Apple at $100 per share. The stock drops to $95, and you still believe it’s a buying opportunity so you average down (buy more). By adding an additional 100 shares, your average price per share improves from $100 to $97.50.
Averaging down improves your pricing but it also increases your risk or exposure to the stock.
Averaging Down – The Good & Bad
If you are averaging down, you are adding to a losing position. That said, averaging down is a strategy that Pros use effectively but one that amateurs implement poorly.
Let’s say a trader is long 1,000 shares of XYZ stock at $5 per share. The trader has a stop loss at $4.50 and a profit target at $6.5o. When the stock drops to $4.60 they buy 1,000 more shares and average down. Their price improves to $4.80, which means instead of the stock rising 40 cents to get to break-even, it just needs to rise 20 cents from $4.60.
Why might this make sense?
Because the trader is doubling their position size and they are only adding about $100 more risk to the trade. Averaging down makes sense when you are at a point where the reward outweighs the risk.
On the other hand, a new trader might average down on a bad idea or trade that has no real edge. They might not have a concrete trading plan and just adding to a loser.
When you average down on a trade you’re adding more risk on. If you don’t have a solid trading plan, one that includes a profit target and a stop loss, than averaging can be a potentially dangerous strategy.
Final Words On Averaging Down
Have a trading plan, if you can add to a stock position without increasing your risk by too much but improve your price than consider doing it. Adding to a loser simply to improve your price is a recipe for disaster.