Trade Like an O'Neil Disciple: How We Made 18,000% in the Stock Market

1.3. AVERAGING DOWN

Trying to buy cheap stocks is but one frequent sin committed by novice or lazy investors. Another lazy man's sin eschewed by O'Neil and his predecessors is the concept of "averaging down." Richard Wyckoff observed, "A great deal of money is lost or tied up by people who make a practice of averaging. Their theory is that if they buy a security at 100 and it goes to 90, it is that much cheaper, and the lower it goes the cheaper it grows."

Retail stock brokers, when in need of a way to avoid taking responsibility for a bad recommendation, often try to use "averaging down" as a way to justify the initial decision to purchase a stock at higher prices. To some extent, this evolved as a convenient corollary to the retail investment concept of "dollar-cost averaging" when purchasing mutual funds, about which we're sure many readers are only too familiar. To O'Neil, this is shameful: "About the only thing that's worse is for brokers to take themselves off the hook by advising customers to 'average down.' If I were advised to do this, I'd close my account and look for a smarter broker" (How to Make Money in Stocks, 4th ed. [New York: McGraw-Hill, 2009], 247).

Jesse Livermore was no less harsh in his assessment of the averaging-down technique when he said, "It is foolhardy to make a second trade, if your first trade shows you a loss. Never average losses. Let that thought be written indelibly upon your mind" (How to Trade in Stocks [Greenville: Traders Press, 1991], 26). ...