Steer clear of the urge to average

Of all the popular stock market concepts, there is none as credulous as the oft followed ‘averaging down'. To put it simply, when the stock price goes down, more stock is bought at lower levels so that the average cost of the stock in the portfolio goes down.

This is done with the hope that the total holding of the stock will move in to profit soon. Emotions have no role whatsoever in trading.

The first thing to do when a trade goes against you is to admit that you were wrong.

Secondly, stick to the stop-loss and exit in time. The loss should not be allowed to grow so large that you feel tempted to average.

Averaging can work sometimes. But if it does not, the pain gets exacerbated and so does the hole in your pocket. Professional traders never average down. They only average up.

In other words, they add to their profitable positions, not to loss making positions.

There is a method to do it, called ‘pyramiding'. The maximum quantity is bought first. As the profit starts building up, half the original quantity is added and then half of the previous lot and so on. To elucidate, if a trader purchases 100 shares of Infosys initially, he will buy 50 more shares more as the price moves up and another 25 as the price moves up further and so on.

The question arises about when exactly to add to your winning position. Those who follow charts can use moving averages, supports and resistances as levels at which to do pyramiding.

Those who do not use charts can pyramid after a certain pre-determined percentage move in the right direction.

It all boils down to the age-old trading maxim — cut your losses rapidly and let your profits run.

So, the next time you feel tempted to average down, don't do it. Book your loss instead. Easier said than done. But then, who said trading was easy.

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