Average Down
What It Is:
Average down (or averaging down) refers to the purchase of additional units of a stock already held by an investor after the price has dropped. Averaging down results in a decrease of the average price at which the investor purchased the stock.
How It Works/Example:
Suppose Bob holds 10 shares of XYZ stock that he purchased at $100 per share (for a total of $1,000). Following a market price drop to $70 per share, Bob purchases 10 additional shares of XYZ (for a total of $700). This results in an average purchase price of ($1,000 + $700)/20 shares = $85 per share, lowering the original cost per share by $15 ($100-$85=$15).
Why It Matters:
Averaging down allows investors to lower their cost basis in a stock, reducing the amount the stock must rise in order to show a positive return. However, it also means if the stock continues falling, losses will be greater since more shares are now owned.
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Cached on February 8, 2012, 1:55 pm