How averaging down works
Averaging down means buying more of a position that has fallen, which lowers the average price you paid per share. The arithmetic is a weighted average:
new average = (shares held × average cost + shares bought × price + fees) ÷ total shares
shares for a target average = shares held × (average cost − target) ÷ (target − price)
A worked example
With the figures loaded above you hold 100 shares bought at $50, and the price is now $40.
- Buying another 100 at $40 takes the average cost to $45 on 200 shares, $9,000 in total.
- The shares now need to rise from $40 to $45, 12.5%, to break even, instead of 25% back to $50.
- To reach a $46 average you would need 100 × ($50 − $46) ÷ ($46 − $40) = 66.7, so 67 shares.
What averaging down does to risk
This is the part most average-down calculators leave out. Say the stop is $36.
- Holding 100 shares, a stop at $36 loses 100 × ($50 − $36) = $1,400.
- Holding 200 shares at a $45 average, the same stop loses 200 × ($45 − $36) = $1,800.
Averaging down added $400 of risk, the new 100 shares times the $4 between today’s price and the stop. The break-even moved closer, but the position got bigger in exactly the trade that is going wrong. That is why averaging down is a sizing decision, not a recovery plan.
When not to average down
- If the reason for the trade has changed. A lower price is only cheaper if the business, or the setup, is unchanged.
- If the extra risk breaks your rules. If the loss at the stop would exceed your risk per trade, the position is too big. The position size calculator gives the size your risk allows.
- Without a stop at all. Averaging down without a level at which you are wrong has no ceiling on how much it can lose. The stop loss guide covers where to put one.
- With leverage. Margin magnifies both the extra size and the risk of a forced sale at the low.
Planned scaling in, deciding in advance to buy in two or three tranches with the total size and stop fixed, is a different thing from adding because a trade hurts. The first is a plan. See how deep holes become with the drawdown recovery calculator.