Business & Investment

Averaging Down: ET Markets Learning Guide: Is Averaging Good for Investors or Bad for Traders?

“Rule 1 never loses money. Rule 2 never forgets Rule 1.” Warren Buffett..In a simple world, that means when you’re out to make money Stock marketMake decisions according to your financial goals.

Therefore, it is essential to understand that market strategies can benefit investors, but the same can cost traders a loss. This principle also applies to averaging strategies.

Investor vs. Trader
Before getting into the concept of averaging, let’s understand the difference between a trader and an investor. Duration is an important factor that distinguishes the two categories.

Both are out to make money in the market, but investors are looking for big returns over the long term with the motto Buy and Hold.

Traders, on the other hand, choose less but more frequent profits. Simply put, traders seek to monetize both up and down markets by making quick entry and exit.

“If you don’t want to own a stock for 10 years, don’t even think about owning it for 10 minutes.” These words by Warren Buffett briefly explain what an investment is and the differences between investors and traders. Explains to.

Investors primarily benefit from the power of compound interest or the reinvestment of profits, and often both. Traders, on the other hand, try to make a profit by buying at a lower level and selling at a higher level. The reverse is also true.

Traders typically see a monthly return of 10% from a transaction, but investors aim for a long-term return of 12% -15%. The goals of the two categories may also be different.

For example, traders aim to buy a car within a few months. The investor’s purpose may be to plan retirement.

The two categories of investment tools are often different. Investors choose to buy large cap stocks and invest in bonds and investment trusts.

Traders prefer more volatile small and medium-capitalization stocks and take advantage of commodity and currency market volatility to make rapid profits.

Simply put, averaging means buying more stock and lowering the overall cost of holding when the price goes down. For example, suppose you buy 10 shares of Company A for 100 rupees per share.

In other words, the total cost was 1,000 rupees. Suppose A’s stock price drops to 50 rupees and you buy another 20 shares for 1,000 rupees. Now you can own 30 shares for 2,000 rupees. In other words, the cost per share is 2,000 rupees / 30, which is close to 67 rupees. This is down from the previous 100 rupees.

And now, if the stock price goes up, you will make more profit. This is also known as the “Buy On Dip” strategy.

Warren Buffett is one of many success stories of averaging. The basis of this strategy is that the market recovers over a period of time.

Proponents of this theory cite the post-dot-com bubble recovery, the 1987 collapse, and the historic post-Great Depression.

Average: Is it suitable for traders and investors?
By its very nature, averaging is primarily a long-term strategy. Therefore, long-term bearish trends can lead to short-term losses and are not suitable for traders.

Traders have a short period of time, so slow recovery can adversely affect their cause. Second, there is no guarantee that the strategy will work 100% in the long run, which increases the risk for short-term traders.

Finally, you can use “buy by dip” or averaging to effectively adjust the timing of the market. Buy at a lower level in the hope that the market will rise in the future. And, in reality, even the best can’t time the market, and even more so in the short term.

Therefore, it is dangerous and a potential loss for traders. However, the evidence shows that averaging is likely to be useful for investors. Investors prefer to expand their portfolio from a long-term perspective.

(The author is the chairman of TradeSmart)

Averaging Down: ET Markets Learning Guide: Is Averaging Good for Investors or Bad for Traders? Averaging Down: ET Markets Learning Guide: Is Averaging Good for Investors or Bad for Traders?

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