The term averaging down, as it is used in securities trading, refers to the effect of unit cost averaging which lowers the average cost of an investment. Averaging down is accomplished by making opening additional investment positions based on an asset which has lowered in price.
By making additional purchases of an asset which has decreased in price, you reduce your average capital loss. Assuming you make additional purchases at a price lower than the price which resulted in the capital loss, your capital loss decreases as your investment increases.
Example of averaging down:
You buy 1000 shares in a company’s stock for 1 Swiss franc per share – a total cost of 1000 francs. 1 month later, the value of the stock has dropped to 95 centimes per share. The 50-franc loss in the value of your shares equates a 5% capital loss.
You buy another 1000 shares for 95 centimes each – a total cost of 950 francs. Your total investment in the stock is now 1950 francs. The 50-franc loss is now a much lower percentage of your total investment in the stock (just under 2.6% capital loss).
If you were to buy an additional 1000 shares in the stock for 95 centimes each – bringing your total investment to 2900 francs, your capital loss on the investment would average down to just over 1.7%.
If you bought an additional 1000 shares for 95 centimes each – bringing your total investment in the stock to 3850 francs, your capital loss would average down to just under 1.3%.
If you bought an additional 1000 shares for 95 centimes each – for a total investment of 4800 francs – your capital loss on the stock investment would average down to just over 1%.
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