Adding To A Loser
A trader or investor who purchases more stock even though the asset’s price is going in the opposite direction of what is planned.
Adding To A Loser Details
The term ‘adding to a loser’ is well-known in the context of trading. It happens when a trader buys more shares of a public company even if the stock price continues to go down or sells more shares even if the stock price continues to go up. Put another way, investors or traders who add to a loser increase their position size in a losing position. Despite what it may seem, adding to a loser can be a legitimate and advantageous strategy in certain situations.
Investors who add to a loser may average their entry position, known as averaging down or averaging up. Average down is a trading strategy where a stock owner buys extra shares when the price goes down, resulting in a decrease in the average entry price. For instance, if you buy 50 shares of a public company at $50, then next time you purchase additional 100 shares at $30, your average entry price would be $40 per share. Average up is a method of selling additional shares when the price increases the average exit price, the exact opposite of average down.
Averaging up or averaging down does increase risk. But, if the price eventually reverses, not only avoiding loss, you may also gain a bigger profit. Of course, you can’t add to a loser simply on a whim; it needs to be part of your trading plan from the start. Remember, adding to a loser can prove fatal if the price continues to move in the direction you don’t want.
Example of Adding To A Loser
Let’s say that a trader buys 50 shares of a company for $100 per share. One month later, the stock price goes down to around $90 per share. He believes this is only temporary and predicts that the price will go up again before long. The trader decides to average his entry position by purchasing additional 50 shares at the same price, resulting in an average entry position of $95 per share (for a total of $9,500).
As it turns out, however, luck isn’t on his side. Stock price continues to go down to $75 per share. If he decides to cut his loss and sell his shares at this price, the trader will lose 21% of his investment (($9,500 - $7,500) / $9,500). Otherwise, he can choose to hold his position, hoping for a reversal, but doing this will significantly increase the risk, especially if done without proper planning.
Adding to a loser won’t always culminate into losses. It can net you a larger profit, assuming you know what you are doing. Using the example above, if the price were to go up to $125 instead, the trader would gain 31.5% of his investment (($12,500 - $9,500) / $9,500). However, even if you have a very well-made trading plan, it won’t result in definite gains all the time, as losses in trading will always happen at some point.
Significance of Adding To A Loser
The main problem with adding to a loser is that it is often associated with impulsive trading. If put into a losing position, traders or investors, especially beginners, are prone to enter a trap where they trade mostly using their emotions. For instance, investors may go into a panic mode if their asset is losing its value and have difficulty accepting this. To combat the feeling, they decide to add to the loss hoping for a turnaround, thinking they will “beat the market” by entering at an even lower price.
The thing is, doing this can put them into a worse state if things go wrong. If adding to a loser has never been a part of their trading plan in the first place, doing it on impulse is rarely a good idea. For experienced traders, they can decide if an investment is worth holding or not, with adding to a loser may sometimes be an additional clever play. The difference is that these traders have already put their plans in place even before they enter the market.