Averaging Down And Dollar Cost Averaging

Averaging down means buying more of a security an investor has already bought at a higher price.

Because of the unit cost averaging effect, averaging down leads to an average price closer to the current (lower) price rather than the original (higher) price.

The effect of this is that it greatly improves the chances that the holding of the security in question will be profitable. However, it does this by diluting the impact of the original holding. It cannot actually create gains where there were none. It obscures the loss made so far by mixing it in with new purchases that will, hopefully, be bought cheap enough to make gains.
 

Unit cost averaging
 

Unit cost averaging is a method of timing purchases to reduce the exposure to fluctuations in the price of the security being purchased. It is also called pound cost averaging, dollar cost averaging etc.

An investor using cost averaging splits a purchase of a security into several tranches which are bought at different times. This has the benefit of smoothing out the effects of short term fluctuations in the share price.

The price that is finally paid will tend to be closer to the bottom end of the range in which purchases were made than to the top end. To see the reason for this consider a simple example:

An investor spends $20,000 buying shares in two tranches of $10,000. The first purchase of 1,000 shares at $10. The price then falls and the next purchase is of 2,000 shares at $5. The average price paid is $20,000 ÷ 3,000 = $6.67. This is less than the first price of $10.

Unless the price is likely to fluctuate wildly, any gains from cost averaging are likely to be outweighed by the additional costs of trading this way.