When you have investments, there would be winners and there would be losers. The question is when do you cut your losses and move on.
Just like in every endeavor there are times you hit the goal or are on track and there are some not so good times that you neither hit the goal nor seem to be on track. Do you give up or keep putting effort?
You might wonder when should you discard an investment and when should you double down on it.
When you average down, you are reducing the overall cost of an investment. For example, you buy 20 stocks of a company at $100 each, after a month the price drops to $50 each, so you decide to buy more. When you buy another 20 stocks at the price of $50 each, the average amount spent on each stock reduces from $100 to $75.
However, when the stock goes up from $100 to $200 and you purchase the same amount, you average up from $100 to $150 for each stock.
The dollar-cost averaging is used mostly in stocks to smooth your purchase price over time and helps ensure that you’re not dumping all your money in at a high point for prices.
When the price of stocks begins to fall, we tend to think it’s time to average down, however, this could lead us to a trap of putting more money in a worthless or dying stock.
To avoid this, we must look at the reason why the stock price is plummeting. This is the only way we can know for sure if we should average down or cut our losses and move.
The same applies when we want to average up, we need to understand why the price is moving in that direction.
Some of the reasons why a stock price might be moving down are due to the company not meeting analysts' targets, change in management such as the exit of founders, etc.