The Biggest Mistake of any newbie investor is averaging down the stock value in a wrong way. New investors often confuse between averaging Down and Pyramid Investing. In Chapter 2, I have clearly explained the creation of Pivot points and investing in any stock in the ratio 1 : 1 : 1.
Averaging Down a stock value is a great way to increase your returns on investment. But when you invest without discipline all your investment may be at risk.
Let’s say Company A has Year High Value of Rs. 150. Due to global slowdown stock price of Company A has come down to Rs. 100.
Rahul and Bharat both are good friends, both are bullish on Company A and they followed the procedure explained in Chapter 2.
The below example is just to explain the risk of Pyramid Investing So I’m not taking Three Year chart into account. I always suggest you to follow the full procedure I explained in Chapter 2.
The Pivot Points are as follows
Company A’s Stock Price @ Rs. 100
Rahul & Bharat, both invested Rs. 1000 each and purchased 10 shares
Company A’s Stock Price depreciated 10% in a single day and reached Rs. 90
Rahul checked the Pivot 2, since the stock value not come down to Pivot 2 (Rs. 70). So he did not make any investment in Company A. Whereas Bharat thought it is a great opportunity as the stock depreciated 10% in a single day and available at a cheap price so he invested Rs. 2000 and acquired 22.23 stocks.
You can’t purchase decimal stocks. Just for the sake example I represented 22.23 stocks in this example. You can either purchase 22 stocks or 23 stocks only
Company Stock Price @ Rs. 80
Rahul checked Pivot 2, and not invested. But Bharat went on to invest Rs. 3000 and acquired 33.34 stocks
Company Stock Price @ Rs. 70
Now the Company A stock price come down to Pivot 2 (i.e Rs. 70), so Rahul invested Rs. 1000 and acquired 14.29 stocks. whereas Bharat does not have free cash in his account to invest.
Company A’s stock price appreciated to Rs. 85
Let’s see the value invested and Return on investment of Rahul and Bharat
Total investment by Rahul = 1000 + 1000 = 2000
Total stocks = 10 + 14.29 = 24.29
Current Value = 24.29 * 85 = Rs. 2065
Rahul’s Profit = Rs. 2065 – Rs. 2000 = Rs. 65
Total investment of Bharat = 1000 + 2000 + 3000= 6000
Total Stocks = 10 + 22.23 + 33.34 = 65.57
Current Value = 65.57 * 85 = Rs. 5573
Bharat’s Loss = 6000 – 5573 = Rs. 427
In case of Rahul, his portfolio is in profits and and having free cash to invest in other emerging stocks. But Bharat’s portfolio is in loss and all his cash is blocked in wrong trades.
Always stick to your plan and invest. No body knows when a particular stock will rise or fall. Be prepared for everything, as an investor you should not connect emotionally to any stock. It is only possible by investing in all stocks equally.
Hi, I’m Sreekanth Thattikota. I use only Fundamental Analysis to find undervalued stocks. I share the stocks that I trust and I invest. Investing in Stock Market doesn’t require any financial expertise, provided it is long term. For any help regarding Stock Market Investing, reach me @ thattikota.sreekanth[at]gmail.com. Happy Investing.