I want to know what is the rule for averaging both on the up and down, which makes more sense. Does it make sense to averge a stock which has already gone up by 3 times, 4 times, 5 times and so on from the initial purchase, especially if you are holding a very few quantities? My own examples are Monsanto, Titan, Tech Mahindra all up 2 to 4 times but hold a paltry quantity.
Binu - Though this question is asked to the experts, but I take the liberty to try answer it. What I have learnt and started believing and practicing is that averaging (or I would rather say adding additional positions) should be purely on the basis of youseeing a value at the current price. I heard great people rightly say that your cost price becomes immaterial since the time your trade is executed. I typically start with some basic hypothesis/story about the stock e.g. it will add ‘x’ number of stores in the next year without taking too much debt and result in increase in same store sales. If the story turns out well, then I see no reason why I should not add whether the current price is above or below your initial purchase price. This is provided you still see value at the current price based on yardsticks such as opportunity to current market cap ratio, expected growth or the more conventional PE, PB ratios (though not a great fan of the latter)
What I used to do earlier and wrongly so was blind averaging as the prices go down. This could be owing to the classic endowment bias or sunk cost fallacy. This typically happens when we buy stocks on borrowed conviction and don’t bother to empirically validate the initial investment thesis. I will give an example.I started buying a useless penny stock called Concurrent Infra in 2011 based on the borrowed conviction of some random stock guru. I bought it at 15, it went up to 30 and then I lost 95% in the next 6 months. All the while, when the stock was going down, it was watching it sink like a stone in water and had anostrich like hope that it will bounce back one day. Same thing with Manappuram Finance 3-4 years back. I had a high level ‘belief’ that it was a great stock in great sector and completely ignored the gold price coming down, competitive intensity increasing, high cost of funds, some corporate governance issues and went on averaging downwards.
To summarize, there is nothing called averaging up or down. If you see value at the current price where you empirically learn that the story is better than yesterday, you buy else you sell. I am reading Nassim Taleb’s Black Swan now and he stresses on being skeptical empiricist in life and this is a classic case where thisphilosophyworks in the practical world of investing. They say market is a great teacher!
Stock going up should be no reason not to average up.
IMHO - In most cases, averaging up is more beneficial in long term rather than averaging down.
Typically one should buy a good business over a period of time - say 5 years. And hold another 5 years for the full cycle to play.
In these five years - you will get ample opportunities to see the management ethics, the business prospects and other factors which may increase/decrease your conviction.
When you are convinced that you are holding a good business with sustainable growth - you should NEVER hesitate to buy it upwards if it has gone up 2-3-5-10 times up.
Even if your average price is increased 2-3-5 times, staying with a winning stock will pay tremendously in longer term with a decent dose of capital.
And similarly you should not hesitate to sell your business if you feel fundamentally something has dented the future prospects. Even if price is lower. Selling your looser timely is one thing which only experience can teach.
Is there a more systematic way of averaging up?, say one finds the next MRF, TTK prestige, Page etc. how does one go about systematically averaging up.I have been trying to average up for several of my holdings such as Cera, Heitage and Tasty Bite.I have been trying different approaches for each of these.
For cera i have been buying in dips,
heritage as and when developments occur which brighten the future prospects ,i add a chunk.
For tasty bite i add fixed chunks of capital whenever the gain hits approx 100%.
But all of these approaches are approximate instinctive methods which I follow whenever have some funds in the bank but no new ideas.
If anyone could share their experiences of averagaing up their stocks as it multiplied several times it would be enourmously useful.