By Lorna Tan

Where do you see this?

In stock investing articles and websites.

What does it mean?

An averaging down strategy is employed if an investor buys the same shares at different prices when the price of the share begins to fall.

By doing so, you are effectively reducing the cost per share and this will result in a higher profit margin.

For example, assume that you buy 1,000 shares of firm ABC at $2.40. The price drops to $2 and you buy another 1,000 shares at $2. The average price per share is now $2.20.

If you had bought 2,000 shares at $2.40, you can make a profit only when the price goes beyond $2.40. But by using an averaging down strategy, you can now make a profit once the price goes above $2.20, since the average price per share is lower. Do bear in mind that you have to take into account brokerage commissions when calculating profits.

Why is it important?

The strategy enables you to increase your profitability and in a shorter time. It is usually adopted in situations where the share price falls but the fundamentals remain strong.

But be mindful of falling markets. Experts say it is prudent to let the prices stabilise or wait for at least three days before averaging down.

So you want to use the term. Just say...

'Oh no, the market is falling. I may have to think of averaging down some of my stocks if I want to make a profit in the longer run.'

This article was first published in The Straits Times.