Investment Myths Busted

[kennynah]

hi tonylim ...

congrats...

i was wondering ... if stamford land had gone down and stayed down at 5 cents today....what would you have done?

cheers

[winston]

I first bought Stamford Land at 0.67, it went down to 0.30 , I bought some. It went down to 0.22 , I bought some, it went down to 0.19 , I also bought some. If I did not average down, I won't be sitting on paper profit today.

Nice move. I did not managed to average down because I have this ringing in my ear that the end of the world is near and that I should never average down.

On hindsight, averaging down was the logical thing to do if we did not managed to cut our losses before the downdraft. It was trading at a fraction of it's RNAV. It has assets in a strong Commodity country.

But hindsight is always 20 /20. For every story that we hear about averaging down resulting in a positive outcome, there's also another story that averaging down has costs other people alot of money.

So I need to reboot on this one. There's a time to average down and there's a time not to average down. We just need to use our judgement to decide on whether it's right to average down on that particular trade and when to execute it.

[tonylim]

Hi Kenny,

If SL went under I will have to accept the reality also.

All investments carry risks , it is either win or lose. No risk no gain.

Thanks and cheers.

[kennynah]

hi tonylim...thanks for the reply...and i think you hit the nail on its head... averaging down is about increased risks and whether one is willing and able to accept it...vs the potential of making money ...

[millionairemind]

hi tonylim...thanks for the reply...and i think you hit the nail on its head... averaging down is about increased risks and whether one is willing and able to accept it...vs the potential of making money ...

Now to present the flip side of the argument....

Just because one is lucky averaging down does not mean one will always be lucky.

[lithium]

I don't use averaging down because I think the risk is too high and I cannot estimated my losses when I initiate the trade, in another words, I cannot or I don't know how to manage my risk.

So I get myself comfortable to cut loss and buy cheaper later. OR cut loss and chase higher later. This way I can manage my risk better.

[winston]

1) Now to present the flip side of the argument....
2) Just because one is lucky averaging down does not mean one will always be lucky.

Ha Ha ... in the first place, I probably will not buy China Energy so there's no need to average down

I like this discussion. It helps me crystallize my thinking:-
1) try to cut loss before the long downdraft
2) if one does not want to cut the entire postion, at least reduce the exposure
3) if one did not managed to cut loss, then one need to be prepared to ride things out for a long time
4) when fundamentals start to change, that's the time to average down. You now know the price action and fundamentals of the company so would be able to make a better informed decision.

[kennynah]

4) when fundamentals start to change, that's the time to average down. You now know the price action and fundamentals of the company so would be able to make a better informed decision.

i am with you on this particular point...
we must always be in tune with the underlying we are at play with... every asset behaves differently, in terms of price action, daily/weekly/mthly volatility range, reaction to external events, etc...

just like having a long lasting relationship with boy/girlfriend/spouse... we need to know when to press and when to release...hahaha...

[kennynah]

Now to present the flip side of the argument....

Just because one is lucky averaging down does not mean one will always be lucky.

i dont disagree with your valid point. in general, averaging on a losing position increases risks and this can be disastrous, if this increased risks is not properly controlled.

let me use a simple example to illustrate when averaging on a losing position does not increase risk and this is my meaning of a pre-planned trade involving averaging down...

Long stock = $10/share
Long position size = 1000 shares
maximum risk amount = $2K
stop loss exit order entered = $8 (once price hits $8, i'm out with a $2K loss)

stock drops to $9.80, i Long another 1000 shares.
reset stop loss order to $8.90 (2000 shares @ average price $9.90. $1 drop = $2K loss)

stock drops to $9.60, i Long another 1000 shares
reset stop loss order to $9.13 (3000 shares @ average price of $9.80. $0.66 drop = $2K loss)

so, while the max risk is still at $2K for this approach, you will see that you need to adjust your stop loss exit from $8 to $9.13. this makes the wiggle room smaller. it means, the chances of being stop out, becomes higher.

at no time, should the stop loss exit be maintained at $8 when averaging down buy in prices. to do so, will cause the max loss to balloon to $5.4K from the original $2K (270% higher than originally intended).

individuals will need to decide if this is a workable approach.

[millionairemind]

K - I like your example. Good risk control.