What is Averaging Up in Stock Trading?

You invest in a stock with the expectation that its price will go up in the future, but at some point you thought that you had purchased a smaller quantity, but the stock has immense growth potential. Then you decide to average it up, but it can significantly increase the average buy price. This is known as “Averaging Up in Stocks”.

In today’s blog post, we will give you an overview of averaging up in stock trading, along with its key benefits and limitations.

What is Averaging Up in Stocks?

Averaging up in stocks refers to an investment strategy in which an investor purchases more shares even if the price has increased from their initial purchase price. Due to this, the investor’s initial purchase price goes up. The primary reason for averaging up is that the investor has strong confidence that the price may rise in the future; there can be various reasons for this, such as a company’s earnings, market growth, etc.

Key Features of Averaging Up in Stocks

The key features of averaging up in stocks are as follows:

• Purchasing at a Higher Price: The shares in averaging up are purchased at a higher price when compared with the current purchase price.
• Increases Price: Averaging up will eventually increase the cost of purchasing by increasing the purchase price.
• Requires Risk Management: As investors are continuously increasing their position, a sudden fall in stock prices can affect the position of the investor in a significantly negative manner.
• Requires Regular Monitoring: While averaging up, investors are required to regularly review the performance of stocks. If the fundamentals of the stock change, averaging will no longer make any sense.

Example of Averaging Up in Stocks

Suppose you hold 100 shares of ABC Limited for INR 100 each, and your current investment value will be INR 10,000.
You have a strong conviction about the future growth prospects of the company. Then you decided to add more shares to your portfolio. But the current stock price is INR 120 per share. 

You have purchased an additional 100 shares at this price. Now your investment will look like.

Purchase	Quantity	Price per share	Investment Amount
First	100	100	10000
Second	100	120	12000
Total	200		22000

Now, let’s calculate the average price per share:

Average Price = Total Purchase Amount / Total Quantity

22000 / 200 = 110 INR per share.

Benefits of Averaging Up in Stocks

The key benefits of averaging up in stocks are as follows:

• Increase Return: If the stocks continue their upward movement, the additional purchases made by the investor through averaging up can increase the return of the portfolio.
• Participate in Further Growth: Generally, investors avoid buying a stock that has risen because they feel the opportunity is missed. If a stock has growth potential, investors can slowly increase their holding instead of waiting for a correction.
• Investment Discipline: There can be a pre-defined strategy that will lead to averaging up, such as a fixed amount of investment after every defined frequency, etc.
• Long-Term Growth Strategy: Averaging up is suitable for long-term investing. If the company continues to increase its revenue, profit, and other metrics, investors are still likely to pay a higher price for such stock.
• No Need to Time the Market: Investors are always stressed about market movements and timing the market. They always find the perfect exit point, which is very difficult for an investor. But consistent averaging up allows them to avoid market timing. 

Risk of Averaging Up in Stocks

The key risks of averaging up in stocks are as follows:

• Overvalued Price: A continuous rally in a stock can make it expensive compared to its intrinsic value. In this case, if the investor continuously averages it up, they might end up buying that stock at an inflated price.
• Trend Reversal: If a stock has been consistently performing well, there can be a chance of a sudden trend reversal because of weak earnings, news, etc. If an investor has consistently averaged up their position, it can result in a huge loss.
• Concentration Risk: Consistently adding stocks at a higher level can make a stock a significant part of your portfolio. If the company faces any problem, this can lead to a large loss.
• Emotional Decision: Investors might feel tempted to buy more of a stock at a higher price because of emotional fear of missing further upside gains. This fear of missing out will lead to speculative rallies.
• Changes in Fundamentals: The financial performance of a company can change suddenly due to factors like interest rates, the economic cycle, sector performance, etc. 

Read Also: What is Moving Averages?

When to Average Up in Stocks

There are certain situations when one can average up in stocks, as follows:

• Fundamentally Strong Company: In case a company continues to consistently report revenue growth, increasing profits, cash flow, etc.
• Earnings are Supporting Price: A stock should be averaged up when the rise in price is supported by the earnings of the company. If the earnings are growing, the valuation consistently remains reasonable.
• Predefined Buying Plan: Averaging up is suggested if you have a pre-defined buying plan based on the results posted by the company every quarter.
• Position Size: Before adding more shares in your portfolio at a higher price, one is advised to adjust the position size, and it must not go above the risk appetite and should not be highly concentrated.

Mistakes to Avoid While Averaging Up

The key mistakes that an investor should avoid while averaging up stocks are as follows:

• Rising Stock Price: A rising stock price does not mean that it is a good stock to buy; before averaging up, one must understand why the stock is moving up.
• Valuation Concern: Ignoring the valuation of the companies and averaging them up is the key mistake that most of the buyers make. Buying stocks at extensively higher prices may lead to little room for growth.
• Over Positioning: Continuously purchasing one stock can make it a large part of your portfolio. And if a company faces any unexpected problem, the investor may face a huge loss.
• No Stop-Loss: If an investor does not follow an exit strategy, they might hold a stock even if it falls below a certain level.

Conclusion

On a concluding note, averaging up is a smart way to increase your position in a stock that has high growth potential in the long-run. Through averaging up, an investor adds more shares of a company that is performing well when the company is performing well in fundamentals, growth prospects, etc. However, before averaging up any stock, investors should look for a company’s valuation, performance, market conditions, etc. But it is advisable to consult your investment advisor before averaging up the stock. Invest in stocks with Pocketful and enjoy zero brokerage on delivery trades, helping you invest without worrying about brokerage costs on every purchase. Whether you are building your portfolio or averaging up on stocks you believe in, Pocketful helps you invest more efficiently. 

S.NO.	Check Out These Interesting Posts You Might Enjoy!
1	What is Pair Trading?
2	Kelly Criterion for Stock Trading
3	What is Quoted Price in Commodity Trading?
4	What is Speculative Trading in Stock Market?
5	1 Minute Scalping Strategy: Best Setup & Indicators