Averaging down is an investment strategy where an investor buys more shares of a stock at a lower price than the original purchase price, with the intention of lowering the overall cost basis of the shares. The idea behind averaging down is that the stock price will eventually recover, and the investor will make a profit from the lower-priced shares.
The strategy is based on the assumption that the stock price will recover over time, so the investor buys more shares at a lower price, in order to lower the overall cost basis of the shares and increase the potential return when the stock price goes back up.
For example, an investor buys 100 shares of a stock at $50 per share and the stock price drops to $40 per share. Instead of selling the shares at a loss, the investor decides to buy more shares at the lower price, in this case an additional 100 shares. This will lower the average cost per share to $45 ( (10050 + 10040)/200) and increase the potential return if the stock price rises again.
It’s important to note that averaging down is a high-risk strategy because it requires an investor to continue buying shares of a stock that has already dropped in price. It may work when the investor has a strong belief that the stock is undervalued and has a strong potential for recovery. However, if the stock continues to drop in price, the investor will be buying more shares at a higher loss. Therefore, averaging down should be done with caution and only when the investor has a strong conviction about the stock’s future performance.