Hello my name is Jelmer and I'm excited to be here. I'm an entrepeneur, trader and investor. I'm trying to find out if Steem works for me. I hope to help traders and investors here, by sharing my knowledge about financial markets (crypto, stocks and commodities).
I hope you guys like this post. If so, please let me know and I'll post more of this.
Averaging down
A well-known phenomenon in investing penny stocks is averaging down. This
strategy is also often applied in other financial products. Averaging down
means that you increase a position that is currently losing.
It can be a useful tool, but with many novice investors it is often applied in the wrong
way. Averaging down is explained by the following example:
Example:
You buy 10,000 shares of share A, at a price of $ 1. Your total invested amount is
therefore $ 10,000. For the sake of convenience, we do not include any commisions. The price then drops to $ 0.50. You decide to do the following:
Your total position currently has a value of $ 5000. You then invest another $10,000 in share A. You can now buy 20,000 shares for the same amount. The total value of your position is therefore $ 15,000.
This means the following: Normally, the shares should go all the way back to the $ 1
price to make up for your full loss. This is different now, because you have decided to double your position on a rate of $ 0.50. You now own 30,000 shares for an average price of $ 0.75, namely (10,000 x 1 + 20,000 x 0.50) / 30,000.
This means that when the price returns to $ 0.75 you have made up for your loss and a price increase to $ 1 is no longer necessary.
Okay, this sounds good, but in practice it often turns out differently. Let's assume that
you did a good research on the company before you decided to buy $ 10,000 shares at a price of $ 1.
At the time of purchasing you were expecting the share to rise, otherwise you would not have made a purchase. Unfortunately, the opposite is true. Your analysis has turned out differently and your total investment has been halved to $ 5000.
Would general electric have been a good stock for this strategy?
According to plan?
Before you started investing, you probably agreed with yourself that you would invest $ 10,000 in this company. You assumed that the share would increase.
In our example, two things are different:
The price falls by 50% instead of an expected rise.
Ultimately, $20,000 is invested instead of $10,000.
Twice as much is invested in shares that do not do what was expected. This does not
sound handy, but there is a chance that you have fallen into this trap once or
more than once. This could of course have been with other amounts or
percentages. Has your strategy worked out well?
Probably not often, but you are certainly not the only one. Some investors make it even worse. It may sound exaggerated, but some investors manage to fall into the same trap again and again.
Unteachable
The following contiguous, somewhat extreme example, unfortunately occurs often:
You have now invested $ 20,000, the double what you originally intended. The total value of your investment is currently $ 15,000. Confidence is brittle among investors due to the 50% fall in the price of the shares. And then.. a bad news message is released by the company.
Panic breaks out among shareholders and there are a lot of sellers. The stock is
halved once more and the price is now quoting $ 0.25. Because you decided to use the funds in the previous fall, the value of your invested capital will fall even faster.
The value of your position is now $ 7,500 while you have invested $ 20,000.
At first you only intended to invest $ 10,000. You decide to open your savings account and you invest another $ 20,000 in the hope the price will bounce….
This is a fairly exaggerated example and this will only occasionally go well. If the price
eventually rises back to the starting price of $ 1, you have made a substantial profit. In fact, you will find yourself brilliant and you will probably brag at parties about how such a good investor you are. However, the following shows that you have taken an
irresponsible risk.
More than you think
Suppose your shares have fallen by 50% in value. Did you know that a 100% increase is needed to make up for the entire loss? The higher the percentage decrease, the
harder it is to make up for the loss. This is clear from the table below:
Price fall Required price rise
5% 5.26%
10% 11.11%
30% 42.86%
50% 100%
70% 233.33%
90% 900%
Here you can see that from a decrease of around 30% it is already very difficult to make up for the full percentage loss.
Please let me know if you want to see more of this, because this is one of my first posts. If so I will post more of this.