Yes to dips but no averaging down!
Yes to dips but no averaging down! is Part 5 of the 7 part White Top View series: Playing Market Odds, covers the difference between averaging down and buying the dip. Earlier in the series, we cover how superior investors play market odds and avoid common investment errors. Superior investors never average down
Do not play high risk odds, do not average down…but buy the dip!
We have looked at both successful rides through price dips and price drops that happened without any sign of significant recovery. Averaging down on some dips would have worked well. The problem comes when averaging down does not work.
Get it wrong and you have to deal with a very costly mistake. Sometimes stocks do fall in a hole and never climb out. Sometimes a stock ridden down never recovers. Stocks die.
Even when there is a price recovery it can take years for averaging down to work. In the meantime that money is effectively dead. Putting it to productive work elsewhere pays off absolutely every time. That move guarantees the odds are in your favor.
To recap, if the economy is positive and the market is positive we then turn to examining each specific company. If there are no substantive negative facts we stay in through price dips. If the facts are substantive and negative, we immediately sell. Take the loss and get the funds to work making us more money in a growing stock.
We do not and can not know it all. Ever. Things happen, things change. Even when ready and willing to ride through a dip, it can have a bad outcome. Significant negative news can instantly change the picture. At times circumstances definitely change. We get surprised. We have it wrong. Our prudent choice, we immediately sell.
One of the great things about the stock market is our ability to change teams. When we know we are on the wrong or losing side we can change teams. Sell the loser and buy the winner.
Averaging down significantly increases risk. Should we be wrong on an averaged down decision, we kill our performance. It goes beyond the single stock involved. Getting an average down move wrong can devastate other investment returns or even destroy your portfolio.
Far better odds favor our overall portfolio performance by passing on the average down strategy. In most cases, even when averaging down works in the case of a single stock there is a negative effect on the portfolio.
Averaging down always impairs overall portfolio performance. This happens because more of your always scarce resources are going into a weak position. Using the alternate or opposite strategy of putting the resources into your strong position disproportionately increases your portfolio performance. When that is possible who wants an impaired portfolio?
Take the averaging down strategy out of your investment management toolkit. That will improve your portfolio performance odds. Then you can accelerate our portfolio. That certainly beats being another averaged down underperforming investor.
In Part 6 of the White Top View series, Playing Market Odds, we discuss how to play that price dip. Links to all seven parts of the series are at the end of this post.
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Links to all parts of this series follow: