Home > Lessons from the trading floor > Averaging down vs. Building a position

Averaging down vs. Building a position

There is a big difference between averaging down vs. building a position!  Averaging down simply means you add to a position or buy more shares because it is going against you and you do not want to accept the loss.  Lets say you want 1000 shares of Home Depot at $24.86, and your original plan was to take a loss if it breaks support at $24.75, instead it beaks below this level and instead of taking a loss, you add another 1000 shares hoping to improve your average cost and hoping it goes back up.  Notice that I highlighted the word hoping. In this business, we can not hope, we must have a plan and have the discipline to stick to that plan.  Ok, now the HD, has made another move down, and you add yet another 1000 shares, again hoping to lower your average price and maybe to break even on the trade.  Remember, your original goal was to only have 1000 shares. At this point, with 3000 shares, you are out of your comfort zone and have broken all your rules.  This ruins more traders’ careers then anything else, taking to much size and usually against the trend and what could have been a small loss with only 1000 shares turns into disaster! SO DON’T DO IT! Believe it or not, this is the way that many NYSE Specialists traded when they got off the floor and tried to make a living upstairs. Unfortunately, many are no longer around for this exact reason.

Building a position is a bit different. Building a positions means you have a certain amount of shares you are looking to accumulate. Lets say you want 3k shares of gm. Instead of buying 3k in one shot, you will buy in small increments. With the volatility in todays markets , you can never really get the exact price you want, so no need to go all in.  I may buy it in 500 share increments in the direction of the trend.  If the stock pulls back, i will buy another 500 at a lower price. If the stock continues to go up, i may also buy another 500.  If you are building a position, you actually want the stock to against you a bit because you still do not have all the shares you wanted and would prefer not to buy them higher.   Please note, we do this in the direction of the trend, so when we buy more at a lower price, we are really just buying in a pullback of the uptrend.




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