Should you Average it Up or Average it Down?

MarketSmith India - Weekly Out Look

“If you let a stock go down 50% from where you bought it, you must make 100% on the next stock just to break even. Now, how often do you buy stocks that double in price?” –William J. O’Neil, MarketSmith Founder

Investors are often reluctant to sell when stocks go down in price from what they paid for them. To add to the harm, many investors tend to average down and buy more of the stock that already shows a loss. Our strategy turns the concept of averaging-down on its head, and we suggest adopting the pyramiding or the averaging-up technique. This strategy ensures that the losers are weeded out, and the capital is instead deployed to winning stocks – resulting in averaging-up your initial buy price. In general, three out of four stocks follow the market direction.

Most institutions, as well as individual investors, hesitate to buy stocks at new highs. Everyone likes a good discount, so they wait for a pullback. The 10-week moving average serves as a key area of potential support. Why? Institutions will use that moving average to add shares to existing positions. Use this investing behavior to your own advantage.

A rising 10-week line is ‘positive,’ pointing to an ‘upward trend’ in the stock’s price. A downward sloping line is ‘negative,’ indicating the stock is in a ‘downtrend.’

While the first two to three pullbacks to the 10-week line are considered proper to buy, the very first pullback to the 10-week line following a leading stock’s strong breakout can provide the most compelling opportunity to acquire more shares, or even initiate a position if you missed the initial breakout from an excellent base. Make sure you buy a smaller amount of shares than your initial position, such as 20% or 30% of your beginning stake. You want to average up slowly in price, not swiftly.

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