Averaging down refers to buying more quantity to bring the average cost down, when the price goes against you. This is a practice generally followed by investors who can hold onto stocks for a long time. The idea is that if you have the ability to lock some of your funds in a position for multiple years, the trade might eventually turn profitable. However, this can also spiral into a wealth destroying habit.
Take the example of Yes Bank, where investors kept buying more quantities of the stock even when it was falling sharply. It eventually fell from ₹400 to ₹10, and the people who averaged down this position lost a lot of money, as the price never went back up again.
Additionally in options trading, time works against option buyers. Averaging down while buying options when their value is decaying with time is not a good idea. Instead of adding more quantity, you should exit a position if your view has been proven wrong. Proper risk management is the only way to stay in the markets for long and to become successful.
There are several techniques you can use to manage risk. Read about the 1% risk rule here.
Also make sure you place strict stop loss and target orders while trading. Learn more about it here.
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