Legal Definitions - averaging down

Averaging down is an investment strategy where an investor purchases additional shares of a company's stock at a price lower than their initial purchase. The primary goal of this technique is to reduce the overall average cost per share of their total investment. This makes it easier for the investor to reach a break-even point or achieve a profit if the stock price eventually recovers.

• Example 1: Individual Stock Investor

  Imagine an individual investor, Sarah, buys 100 shares of "Green Energy Solutions Inc." stock at $70 per share, totaling $7,000. A few weeks later, due to unexpected market news, the stock price drops to $50 per share. Believing in the company's long-term potential, Sarah decides to buy another 100 shares at this lower price, spending an additional $5,000. By doing this, Sarah now owns 200 shares for a total investment of $12,000 ($7,000 + $5,000). Her new average cost per share is $60 ($12,000 / 200 shares), which is lower than her initial purchase price of $70. This illustrates averaging down because she bought more shares at a lower price to reduce her overall average cost.

• Example 2: Retirement Fund Manager

  A portfolio manager for a large retirement fund initially acquires a substantial block of shares in a well-established pharmaceutical company at $150 per share. Several months later, the company faces a temporary setback, causing its stock price to fall to $120 per share. The fund manager, after careful analysis, determines that the company's long-term fundamentals remain strong and the current dip is an opportunity. To improve the fund's position, the manager allocates more capital to purchase additional shares of the pharmaceutical company at the $120 price point. This action of buying more shares at a reduced price helps to lower the average cost of the fund's entire holding in that company, demonstrating the averaging down strategy.

• Example 3: Small Business Owner Investing Surplus

  A small manufacturing business has surplus cash and decides to invest in a key supplier's publicly traded stock to strengthen their business relationship and potentially benefit from its growth. They initially buy 50 shares of "Industrial Components Corp." at $90 per share. A few months later, a sector-wide slowdown causes the supplier's stock to drop to $70 per share. Confident that the slowdown is temporary and the supplier is vital to their own operations, the business owner decides to invest more surplus cash by purchasing another 50 shares at the $70 price. This move lowers their average cost per share for their total investment in the supplier's stock, an application of averaging down to improve their investment's future potential.