Five Reasons to Average Up Instead of Down

Aaron Hodson May 08, 2013

Peter Hodson

After watching stocks such as Enghouse Systems Ltd., Amaya Gaming Group Inc. and CGI Group Inc. hit new 52-week highs almost daily this past week, we received a lot of questions from investors about whether they should sell, take profits or take some off the table.

But one question really stood out: "Should I average up?"

Generally, most investors think it is better to average down, that is, buy more shares of a company when its shares are on sale. The idea being to increase your share bet and profit handsomely when shares recover. This strategy can work, but more often than not you end up owning more shares in a problem company.  That's why we far prefer investors average up. This works best, of course, in a rising market, but we think that is the case right now. Even in a bad market, you often end up owning more of a winning position, which is never a bad thing.

Here are five reasons why averaging up is better than averaging down.

  1. Happy investors sell less
    We have all been there: Owning some loser stock you just want to be done with. You don't care, can't stand to look at it and just want out. This creates additional selling on stocks that aren't doing well. Call it window dressing or simply frustration selling, but bad stocks tend to be the first to be sold. Buying on the way up, on the other hand, gets you into a stock that
    investors like, feel good about and makes them look good. That's a much better scenario overall.
  2. Avoid problem companies
    We all know the phrase "catching a falling knife." It is painful buying a stock on the way down, only to be faced with more problems and more losses. Ask the poor (very poor) investors who bought Poseidon Concepts Corp. (stock suspended) at $12, $5 and $2 as the stock went all the way down to zero. Buying on the way up at least avoids stepping on a bomb.
  3. Higher market caps attract more investors
    Small companies have a tough time attracting investor attention. But as a company's market cap rises, so does investor interest. A rising price simply means more buyers, especially in Canada where there is so much money focused on so few companies. Once a company's shares rise enough to get its market cap to, say, $500-million, its valuation improves because liquidity and trading pick up. It is the exact same company, but it's suddenly worth more to investors.  Averaging up can get you in front of this move.
  4. Buy into higher earnings momentum
    A rising stock price means things are going well and other investors have noticed. Often, it is because earnings are accelerating faster than expected. This was the case with CGI last week. It's not foolproof, but buying into earnings momentum often results in good stock gains. In general, when business is good, it doesn't suddenly reverse course overnight. Averaging up gets you into this momentum stream.
  5. Get a multi-bagger
    You can never triple your money on a stock unless it doubles first. If you want a stock to go up 10-fold while you own it, you can¹t be afraid to be a buyer when it is already up five-fold. It is simple math. Averaging up into your winners can get you a large position into a rapidly rising stock, and it doesn't get better than that. Plus, you know you have friends (other investors) on your side as the stock rises. Others with lots of money confirm your investment thesis and, as a result, your confidence level rises in owning a larger position in that company for a longer period of time.

Peter Hodson, CFA is CEO of 5i Research Inc., an independent research
network providing conflict-free advice to individual investors
(www.5iresearch.ca).

3 comments

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Kevin
Feb 5, 2021
I think you need to look at areas of resistance and support as well over the past month, 3 months, 6 months and one year, especially now, to see how it was affected in March 2020, and through some other pullbacks, and how much time it took to recover after that, if it even did recover. Important to have an idea of what you think is a good value for it as well. I also try to compare to other similar companies in the same sector and to whatever index it is trading close to.
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Brenda
Jun 14, 2016
Doesn't always work. My averaging up on AYA is one of regrets - BIG regrets!
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Bruce
May 22, 2016
I learned something huge here.. I have done this before during successful runs and had success but didn't even realize I was averaging up in your speak. It's great to coin a term and use it so you can influence your behaviour in the future. I see it in real estate investing too. People buy one nice house for cheap 1 years ago but are afraid to buy more when they should be averaging up!