What is Averaging in the Stock Market?

Assume you bought a Reliance Industries stock and its price dropped sharply after you purchased it. How will you feel?

You will feel sad about it.

The journey of the stock market is full of ups and downs. Sometimes it is exciting, but most of the time it is horrible. As per the data, around 95% of traders lose money in trading.

Many of them lose in 1000s, some in lakhs and few of them lose money in crores too.

This is where the concept of “Averaging” comes into play. This is a strategy designed to help you navigate these market fluctuations and potentially benefit you in the long run.

Let’s deep dive into the powerful trader’s favourite concept named, “Averaging in Stock Market”.

What is Averaging in the Stock Market?

Imagine you plan for a Diwali party at your home. You thought of serving mangoes to your guests. You went to buy mangoes in the fruit market.

You see one vendor selling them for ₹100/kg each in the morning. But, another vendor sells them for ₹80/kg each in the afternoon.

What if you could buy half your mangoes from each vendor, getting an average price of ₹90 per kg? This is the basic idea behind averaging in the stock market.

Instead of buying all your shares at once. You purchased the shares over time, buying at different prices. This helps in adding more shares to your bucket, averaging the buying price and reducing the impact of market fluctuations on your overall cost per share.

In simpler terms, averaging helps you to “average out” your cost by buying some shares when the price is high and others when the price is low.

By following this way, you’re not dependent on buying at the peak or the bottom, potentially leading to a more balanced cost in the long run. Averaging is good if you make a small wrong decision at the start of your trading journey.

There are 2 types of averaging:

  • Averaging Up
  • Averaging Down

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Different Averaging Techniques

Averaging Up

Averaging Up is a strategy where an investor tries to buy a stock at higher prices in the hope that the share price will keep increasing. Assume you wish to buy one Tata Chemicals Share. Here’s how it works:

TimeStock PriceShares BoughtValue (in ₹)
9:55 am100101000
10:00 am105101050
10:07 am110101100
10:30 am120101200

The average price comes out to be: Total Value/Number of Shares bought i.e. 4350/40 = 108.75

The average price comes to be: ₹108.75

So if a trader has directly started a transaction at 10:30 am, he/she might have only 10 shares at a price of ₹120.

Remember: Averaging up is a risky strategy. If the stock price continues to fall, you could end up buying more shares at a loss.

Averaging Down

Averaging Down is a strategy where an investor tries to buy a stock at lower prices in the hope that the share price will eventually increase at the end of the day.

The most important benefit of averaging down is, it lowers your average cost per share. If the stock price recovers, you could potentially break even or even make a good profit.

Note: Averaging down of any stock requires high patience and discipline. Don’t average at every small dip.

After averaging up and down techniques, there are some similar averaging techniques that benefit investors.

Systematic Investment Plan (SIP):

Commonly it is called SIP. SIP is investing a fixed amount of money at some particular intervals of time, regardless of stock price. This helps in giving you a profit in the long term.

As per the data, SIP contribution crosses ₹1 Trillion mark in FY24. Also on average, for large-cap equity funds, there is more than 12-18% of annual return. You can calculate your SIP returns by using this SIP Calculator.

Benefits and Drawbacks of Averaging Strategies

It helps traders to book more profitIt has a risk of booking more loss
It reduces impact of market volatilityIt has NO guaranteed success
It promotes discipline and consistency in your investment approachIt requires a huge patience and dedication
It reduces the impact of market volatilityYou can lose your profit in more successive averaging.

When to Use Averaging in the Stock Market?

There is NO fixed technique used in the stock market to gain more profit. Every strategy is used as per the conditions, market fluctuations, fundamental analysis, technical analysis, etc.

In the same manner, averaging doesn’t work everywhere. Consider these factors before you use averaging.

  • Long-term Investments: Averaging is best when you are investing money for the long term. Yes, it can work for a small term too, but you must be an expert trader to predict the behaviour of the stock.
  • Risk-taking capability: Averaging down is risky if you make a mistake in stock prediction. Never do averaging down if you don’t believe in your thoughts.
  • Market Conditions: The market fluctuates due to many unexpected factors and events. You actually don’t know when you will lose money because of averaging in the wrong market conditions.

Considerations while Averaging in the Stock Market

Before diving into averaging, consider these additional risks and factors:

  • Dedicated Time: To observe the trend and take appropriate action, you need to dedicate a fixed time.
  • Transaction Cost: The stock broking app will charge you more if you keep executing orders to average. If incurring profit is way more than executed order brokerage then, it’s good.

These 2 considerations are way more important when you consider averaging in the stock market.

Averaging is a Saviour

Averaging works great for millions of traders and it works badly for other millions too. The difference is when you use it and how you use it. So averaging can be the most valuable tool. Understand the risks and considerations before you do averaging.

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