Average Down

What is Average Down, or Dollar Cost Averaging? Perhaps you have a favorite stock that has been steadily increasing in price and performing well. Then a great opportunity comes along when the price drops, so you buy some additional shares.

Called averaging down, your average price for all the shares you own on that stock has now decreased. "Who cares?" you might ask, but if you are measuring the cost basis for that stock, this reduces the amount the price has to go up in order for you to show a profit. But you also risk losing more money if the price continues to go down. Let's say you own 20 shares of Pull Me Down, Inc. that you bought for $150 per share, for a total value of $3,000. Then one day you notice the price has dropped to $100 per share, so you decide to jump on the opportunity and buy 20 additional shares for a total value of $2,000, since you really believe in the future profitability of the company. Your average purchase price is now $3,000 + $2,000/40 shares...to equal $125 per share, lowering your original cost per share by $25.

Some investors would view a price drop as a positive, while others caution that it is a sign the stock might go down further. Experts recommend that you average down only for blue chip stocks that have a positive long-term track record, good cash flow and not a lot of debt.