What is Averaging in Stock Market?

What's Averaging?

Averaging is a combination of several comprehensive trading strategies in the stock market. It involves the basic principle of decreasing or increasing share prices to counter market volatility. A trader can use a variety of averaging strategies in different market situations. Averaging can be used to decrease the cost of newly acquired units in an emerging bull market.

This is when one's holdings are incrementally augmented by strong fundamentals like an increase in PAT or consistent revenue growth. Averaging is used to decrease one's loss and increase revenue. Averaging does not only apply to losing trades. Here are some examples of the many ways that you can average stocks.

How to use Averaging in Stock Market's cash Segment

These are some of the averaging strategies that traders use in the cash segment of the stock market.

1. Average Down

This is the most widely used averaging strategy. This is done by buying more shares when the share price falls after initial purchase. The average cost of all shares is lower when you buy more shares. This also leads to a lower breakeven point. The following example illustrates this. Let's say that A and B have bullish opinions about Asian Paints' performance. Both have the same profit target for their stock of Rs1,250. A decides to invest Rs1 lakh in investable capital as a lump-sum at point X.

B analyses the volatility of the stock and invests half her Rs1 lakh at point X. She then receives another opportunity to invest Rs50,000 at point Z, which is her support level. B's breakeven point was reduced to Rs1,121 by using the averaging strategy. Once the share price reaches Rs1,121, she can exit her trade profitably. A can wait for the Asian paint share to reach Rs1,180. This was his initial purchase price. He will then be able to breakeven.

2. Average Up

The bull market is well-known for its use of the strategy of accumulating up. This strategy allows traders to buy new units when they feel the stock's original trend is still valid and has significant growth potential. Let's say A has a bullish outlook on XYZ stock and buys 100 shares at Rs1,660. Assume that XYZ stock increases from the initial price. A now believes in his bullish judgment and makes new purchases at Rs1960 & Rs2250.

A anticipated that the stock would trade higher at these levels so he increased his transaction cost to Rs 5,87,000. This strategy allows A to buy 300 shares of XYZ for an average price of Rs1,957. B, however, with the same bullish expectations, but who didn't average up his position, finished with 100 shares. His net profit at Rs2,529,000 is when A leaves his position. B's net profit, on the other hand, is Rs1,14,000. Averaging up in bull markets can prove very profitable.

3. Pyramiding

Pyramiding is a highly aggressive trading strategy. It involves compounding existing positions as the share price moves in a desired direction. Because it involves increasing the average price through the addition of new positions in trades where they expect bullish growth, it is classified as an averaging strategy. This strategy is best for traders who are able to manage high-risk situations. The trader can always take a new position at his discretion, based on chart pattern breakouts, moving-average breakouts, penetration resistance levels, and other technical analysis.

The compounding works in their favor as long as they are able to ride the trend. It can quickly turn against them if the trend in price reverses. Pyramid traders tend to be in the top or bottom position of a trend, and it can become difficult to reduce losses when the trendline changes. To minimize high losses, a stop-loss is essential. The standard pyramid strategy is to buy the largest position at the beginning of a company and then add new positions in a more scaled-down manner. There is also an inverted pyramid, which involves adding new positions to valued stocks in equal increments.

Averaging in the stock exchange is a common trading strategy. It involves scaling up or down the share price to reduce market volatility. There are several ways to average your prices, including up or down. You can also use a pyramid strategy. This strategy is suitable for experienced traders and is high-risk.