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How to average down in the stock market

The stock market is well known for extreme price swings and the Covid-19 bear market will go down as one of the biggest in history. But even with the beating some portfolios have taken investors can use a downtrend to lower the break even of stock holdings. Here's how.

Ideally, stocks could be sold as soon as a sell signal is detected. However, the reality is some investors will ride a stock down no matter how far it falls. Whether it's a buy and hold philosophy or an attachment to a stock an investor can undertake a strategy to not only reduce the impact but accomplish the following:

  • lower the break even point.

  • provide some relief to anxiety associated with big sell offs.

Take advantage of market declines

Here's one strategy with illustration on how it works. Let's use an example of a stock currently at $50 mired in the midst of a down trend. We own 100 shares of our stock. Here's how we manage the downside to make more on the recovery later.

Enter a stop loss (sell) order; leave it open for an extended period of time. If the order is filled because the price fell follow the next step.

Enter an open buy order at a lower price. The challenge is to determine what price to use. There are several historically useful price points but without getting into those details here let's use a price 10% lower than our sell price. Here's how it might look.

How a stop loss works for you

In our example we created the scenario where the stock continued to fall after our (first) buy back at $44/share. The net affect was two sells (on stops) and two buys at a price approximately 10% lower than each stop (sell). The table above is using approximations to keep it simple. The bottom line is we cut our break even price to just over $40/share ($40.55) from what would have been $50 if we had just kept it through the down turn. How about that!

Sometimes a change in how we operate feels drastic. To lessen the impact of this new strategy, leg into it by using it with one security to start. You could even use it with a partial position of one security. For example, you hold 300 shares of ABC; set up an initial stop loss with 200 shares of ABC. As you become comfortable with the process it can be rolled out to more positions in the portfolio.

Don't let the stock market eat up your portfolio. Take advantage of price swings in both directions. For more strategies and trade tips such as this use a subscription and review the daily updates.

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