Don’t Fall for Investing’s Biggest Lie

A single lie has been touted as sound investing advice by brokers and financial advisors for years. And this lie has cost investors like you millions of dollars…

Today, I’ll help you squash the lie for good. In its place, I’ll show you a simple trick you can use to improve your investing performance. This technique will help limit your losses. And it will help you make more money when one of your stocks makes a big run.

The Wall Street lie I’m referring to is commonly called “averaging down.” This strategy involves buying additional shares of a stock when the price drops. The idea is that the investor is lowering the average price he pays for shares.

But in most cases, averaging down quickly becomes a disaster.

Let’s say you buy 1,000 shares of a $10 stock. The stock is in a company that owns a small fast-food chain. According to your research, the company is planning to double the number of restaurants under management from 50 to 100 over the next three years. So you put $10,000 on the line, hoping shares will rise as the company expands.

Unfortunately, the expansion does not go exactly as planned. The economy softens. Sales weaken at existing stores. The company’s margins are pinched as consumers crack down on spending and demand larger discounts. Finally, an earnings miss sends shares plummeting double-digits in one day.

It’s been one year since you first purchased your 1,000 shares. Because of all the setbacks, your $10 stock is trading at $5. Your $10,000 initial investment is now worth only $5,000. But you still like the stock. You believe the company will right the ship when economic conditions improve. So you buy another 1,000 shares, paying just $5 per share this time.

On the surface, you can easily justify this move. By purchasing another 1,000 at a discount, you have effectively lowered your average entry price to $7.50 per share. You’re doing what every financial advisor tells you to do. You sit on your hands and stick to your belief that the stock will eventually go up.

However, that’s not how the market always works. Averaging down is throwing good money after bad.

Instead of improving your situation, you’re tying up even more money on a losing investment. Using our example, your fast-food stock would still need to rise 50% to bring you back to breakeven. And that’s after you’ve already doubled-down on your investment. That’s money that could have been put to use buying another stock.

This is precisely why you need to change your investing mindset. The lie of averaging down only causes pain and suffering. But you can break the cycle (and see tremendous gains) by going against what nearly every financial advisor has preached since the beginning of time.

Instead of buying more shares of a stock when the price drops, you should “average up.” You should only buy more shares of a stock after it has moved higher than your original purchase price.

I know this might sound strange. But it’s a sound strategy that many successful traders and investors have used for decades — even though it’s rarely mentioned by any Wall Street pros.

Here’s how it works:

You buy 1,000 shares of a $10 stock. Your stock begins to rise, eventually hitting $12 per share. The stock is trending higher, attracting more buyers. You notice that volume is expanding, and positive news stories about the company’s success are beginning to appear.

Convinced that the stock is in the midst of a powerful new trend, you buy 250 additional shares at $12. You move your stop loss for your entire 1,250 share investment to just below this new entry point. Then, let’s say the stock moves to $15 in just a few months as its uptrend accelerates. If you sold your shares at $15, you would have a profit of $5,750.

That’s an additional $750 in gains because you bought a small position at a higher price.

Of course, if you had reason to believe the trend would continue, you could again add to your winning position by purchasing additional shares at $15. Just be sure to limit your risk by moving up your stop loss. That way, you won’t lose money if the stock unexpectedly drops below your most recent purchase price.

Averaging up works for two key reasons. First, you are actively building a position in a winning stock. Instead of idly watching your gains, you are increasing your profits by moving additional money to your strongest positions. You’re also making your money work for you on your own terms. When you buy into the lie of averaging down, you are forced to expand how long you expect to hold your investment. One year becomes three years. Three years become five years. Before you know it, you’re holding an investment for half a decade — all in the hopes that you break even.

Averaging up will help you break this cycle of disappointment. It takes just seconds to implement the strategy. If you average up consistently, you’ll be rewarded with bigger, faster gains. And you’ll never go back to the lie of averaging down again…

Sincerely,

Greg Guenthner
for The Penny Sleuth

Don’t Fall for Investing’s Biggest Lie was originally featured in the Penny Sleuth.

This story was originally featured on Penny Sleuth.

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