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One of the biggest flaws in my decision-making process caused me a lot of anguish and a few losses in the early part of my investing career.
It was the idea of averaging down or buying more of the stocks from my portfolio after they fell from my original buying prices just so that I could ‘average down’ my costs.
The math is simple. Assume you buy 100 shares of ABC Co. for ₹120 per share. Your total investment is ₹12,000. The stock falls to ₹90, because the stock market falls, and you buy 100 more shares. Your new investment is ₹9000. Your total investment is ₹21000 (12000 + 9000) and for a total holding of 200 shares, your average cost now stands at ₹105. You have ‘averaged down’ your cost.
Now, this is not a problem if the underlying business remains good but the stock has fallen just because the overall market has taken a hit.
Anyways, ABC Co. falls from ₹90 to ₹60 because there is a rumour in the market about some mismanagement in the company, but you ignore that. You buy 100 more shares for a total investment of ₹6000. Your total cost now is ₹27000. Your total holding is 300 shares. Your average cost of total holding is ₹90.
You feel happy seeing your average cost come down, from ₹120 for the first transaction to ₹90 for the total of three transactions.
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