Averaging stock positions not always a good market strategy. Here's why

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Markets were jittery this week as well, and now that they have been consolidating for the past 6 months or so, the popular advice doing rounds is to buy the dip and average down on existing positions. While averaging down does seem intuitive, it has been observed to be a wealth destroyer for many investors.

When investors average down, they either take a contrarian approach or hope for the stock’s past performance to replicate in the future.

For instance, let’s say a stock was worth Rs 150 in the past and you entered the stock at Rs 100. Now, it has fallen to Rs 80. In this situation, many investors, especially retail, tend to hope that the price will rise back to its previous highs, without examining what has caused the stock to almost half. So they double down their position, feeling elated that their average cost has dropped but the reality is that now they have a higher allocation to a trade, which is more likely to be a losing one.

This is primarily because investors fail to understand that going against the trend can also mean that you are overlooking the risks that are causing others to sell. Also, averaging down is susceptible to behavioural biases such as the Sunk Cost Fallacy and Loss Aversion. The former is the phenomena in which a person is hesitant to leave a strategy because they have invested substantially in it, even though abandoning would be more profitable, whereas the latter is the phenomenon in which investors are apprehensive of accepting losses.

Further, the fact that stocks that have collapsed due to lacklustre fundamentals or due to poor corporate governance, such as DHFL,

Communication, Suzlon, etc., tend to have the highest retail holdings, which also proves this point. This is because smart investors generally exit such positions post seeing signs of stress in the company, rather than averaging down on their investment.

So, the key takeaway is that averaging down only makes sense if you are convinced that the fundamentals of the company have not deteriorated and that the future prospects are likewise appealing. Else, you will end up fitting into the popular phrase ‘Losers Average Losers’, coined by the famous hedge fund manager, Paul Tudor Jones.

Event of the week
The market has been debating and researching on LIC for months and now the much-awaited IPO is set to hit the streets. In an attempt to entice investors, ensure enough liquidity and also initiate meeting their disinvestment targets, the government has decided to sell a merely 3.5% stake in LIC. Even post the reduced issue size, LIC remains the biggest IPO in Indian history and is expected to test investor appetite next week amid bumpy markets globally.

What’s surprising is that IPO is valued only at about 1.12x of its embedded valuation, much lesser than what was being speculated by market participants. Given the ultra reasonable valuation of the insurance behemoth, an upward re-rating of the private players is off the table as of now.

Technical Outlook

ET CONTRIBUTORS

Nifty 50 Index closed on a negative note and continued to consolidate in the range of 16,900 to 17,350. The support zone around 16,800 is established as a very crucial level as there have been multiple rebounds from these levels.

Last week Nifty formed a Doji candlestick and this week the index has formed an inverted hammer pattern just around the support zone. This hints that a minor bottom is in place and possibly a breakout on the upside is expected.

We suggest traders maintain a bullish stance on Nifty for a couple of weeks, targeting a retest of 18,000 levels. A strict stop loss just below the immediate support of 16,850 should be maintained.

Expectations of the week
The main headliner globally would be the FOMC meeting, and it is largely expected that a 50 bps point hike is incoming. If Fed’s actions are more hawkish than expected, knee jerk reactions may be seen. Also, the unemployment rate will be tracked closely.

Back home, the monthly auto sales numbers are bound to pique the interest of investors attempting to forecast future trends in auto stocks. Also, as India’s biggest IPO, LIC, is about to hit the street, there may be some impact on the secondary markets considering that liquidity will be channelled towards the IPO.

Given these events and the current earnings season, the volatility experienced this week is expected to continue into the following one as well.

Nifty 50 closed the week at 17,102.55, down by 0.40%.