- Always buy only in a down day for the stock
- This would get you better prices when others are dumping. BE PATIENT, do not ignore this rule and chase after a running stock, do not be egged on to swing the bat, the market is full of opportunities even if this one is gone. What matters is that each and every single ‘buy’ does not lose money. Invest in haste and repent in leisure.
- As a stock moves up away from you, you might think that the next ‘down day’ would be at a much higher level from today. While that is possible, more often than not, ‘down days’ can easily wipe out days and weeks of gains, allowing you to buy at more bargain levels when greed turns to fear and dumping occurs. Keep your cool and not be swayed by Mr Market.
- Determine that maximum position that you would commit for the stock. For each purchase, do not exceed 25% of that maximum position.
- Buying power is king (i.e. cash). If opportunities present themselves to buy lower (which happens more often than not), you need buying power to take advantage of that. Without buying power, you are out of the game to improve your returns. The bulk of the gains from value investing occurs when you are able to buy a ton at ever lower prices.
- Space out purchases of a stock. Do not buy the same stock two consecutive days in a row.
- In a down market, stock prices take some time to crash as more investors know about the event and/or more people sell off in response to the sell off (e.g. technical chartists, people selling off when its too painful, etc.). Spreading out the purchase increases the chance of getting better prices. Don’t be greedy by thinking that you would miss out on the next day’s low price.
- Only average down when there is at least a 2% drop from the previous buy price
- Stocks seldom stay at the same level. This is to prevent the situation where you end up accumulating a bunch of stock all around the same level. Without new information or new analysis, the amount of stock you want to buy at a price level would be the same. If you end up accumulating, you might as well have bought the whole lot at the original purchase price. The end result is nonetheless also undesirable to end up with a large position bought at the same price.
- Never “average up” unless there is a change in the analysis or new information came that changed the analysis.
- The gains of most value investing “trades” are made by averaging down. This is the most logical – if you think that the original purchase price was a bargain, a lower price is an even greater bargain.
- There is a human tendency to buy more on an uptrend because as the stock moves higher, you will think that it will go even higher because of the recency effect, you feel good thinking that a “buy” was a great decision, you become greedy and want to increase your position to earn more profits, you start to look for signs that justify the current price is a good price (e.g. charts stretched out a certain timeframe to show that the current point is a “low”), you “see” what you are looking for, you become fearful that the stock will move up and leave you behind, you think that the current price is a good price which will be hard to come by in future. These psychological illusions will cause you to purchase shares at higher prices and at larger volumes, exactly the opposite of what you should be doing!
- If you think about it, if you are buying stocks when the prices move up, and you are averaging down when the prices go down, you are literally buying stocks every single day – that is not reasonable. Buying stocks that have moved up because they have moved up is pure short-term speculation.
- When averaging down, try to buy matching the original dollar amount invested
- Maintaining the dollar amount invested (as opposed to matching by number of shares) will result in buying more units at a lower price. This will help to increase profits.
- The mistake of buying a large position at one shot, is much worse than the mistake of selling a lot at one shot. This is because stock price drops are generally more severe and steep, while stock price increases are generally more gradual (typical human behaviour of panic and greater fear of loss compared to same magnitude of gain).