Averaging down: Why you should buy more shares when the price is falling?

Most of us know what it feels like to buy a share that drops sharply in price shortly afterwards. Deciding what to do next can be surprisingly difficult – not least because it’s hard to admit that we may have made a mistake.

That’s why some private investors end up following a strategy called “averaging down” when their investment decisions go against them.

Averaging down involves buying more shares after they fall in price, lowering the average cost of all the shares held and thus the point at which the overall trade breaks even.

Here’s an example of how averaging down works. Say you purchase 100 shares in a company for £1 each and the price then halves to 50p. You then buy another 100 shares at 50p. To keep things simple, let’s ignore dealing costs and taxes such as stamp duty.