When and How to average ?
Though the broad basedstock indices are down by about 6% from the 52 week highs, many stocks specially from the mid and small cap category are down by 15% to 20%. Since last 18 months the stock indices moved upwards only and investors are sitting on good liquidity to average down the existing stocks. Investors are often confused as to when and how to average. First things first, averaging should be resorted only if there is a scope for further increasing the weightage of the stock in your portfolio.
Also, if you are using Stop Loss and the stock is near to Stop Loss then avoid averaging.
Averaging should be performed based on percent changes and not on absolute change in shareprice.
When to average?
If the investment horizon is less than 24 months then better avoid resorting to multiple averaging, as the probability of bounce back are limited. If the investment horizon is more than 24 months then it makes sense to keep averaging, as and when the opportunity arises.
Upside or downside averaging?
Consider that you are invested in a stock whose future is very bright and you have a high level of conviction. Also, assume that you have given adequate weightage to this stock in your portfolio.
Now this company bags a huge order! Since the story has become better and if the valuations are attractive investor can buy more shares even if the stock is trading above the last buying price.
It is not whether the share price is ruling above or below your last buying price but it is the real worth of the stock which should dictate the averaging.
How to average?
One of the ways for averaging has been discussed above. The second reason could be the stock price has come down along with the market. If the prospects of the company are intact then through experience I found that averaging helps the most if it is resorted when the share price is at least 15% down from the last purchase price. In case you do not have cash to invest and still want to average then the best option is to sell a part of the stock which has a less compelling story.