People who watch the market closely tend to be active. They become bored and restless and want to do something even when the conditions are not favorable. This bias leads to the most common advice in a bear market: building positions by averaging into them.
In theory, this is a great idea. No one can time the market with great accuracy, so a good way to build a position is to make smaller purchases over a longer period of time and hope that the average entry price ends up being pretty good.
There is no disputing the wisdom of entering jobs incrementally, especially in a poor market, but this strategy can be challenging. The most common mistake is to insert a medium into a position that is too large and too fast. When there are too many positions in a poor market, there is an increased risk of panic selling.
The problem is that market participants have a very strong bias towards premature action. They want to act, and they also want to try to time the exact lows, and the combination of the two tendencies is that they act too soon.
Better to Buy Later rather than Early
In previous columns, I have discussed my view that it is better to buy later than early. If you buy after a low has occurred, there are precise support levels, and there is a greater chance of sustained momentum. When you buy into the teeth of a decline, you have to expect that the downward momentum is about to stop and reverse. When the market is oversold, there can be some good countertrend bounces, but market lows are extremely difficult to predict prospectively.
Averaging positions in a bear market is likely to do more significant damage to accounts than anything else. The big risk is that the time is wrong, and that the position becomes very uncomfortable and that Preab refuses. This shows strong emotions and causes panic reactions.
It is also necessary to recognize that there is a risk that you may be betting on the wrong stock. Not all stocks that sink in a bear market rebound when conditions improve. If you keep adding to it as it goes lower, you are setting yourself up for a big loss. This is another reason why it is important to seek some strength before you contribute to a job.
I’m a big fan of an incremental approach to trading and investing, but far too many people get it wrong. They are too focused on buying weakness and trying to time the bottom. You have to be willing to build on a strength and not just a weakness. People usually want to buy weakness because the illusion is that they are getting a bargain, but by investing, you make the big money not by buying the low but by buying a sustained uptrend .
This is a critical point that most market participants anticipate. That doesn’t mean a stock will go up a lot. Buying low is not a great strategy if there is no significant value to sell in a relatively short period of time.
I strongly recommend using the ‘average in’ strategy, but I would modify it in two ways. First, use short-term volatility to trade the position. If you get a bounce, then reduce the position and look to repurchase as conditions improve. Second, look to build the core position on strength rather than weakness. Don’t buy endlessly as the price goes lower. Make the stock prove it has some relative strength before you trust it.
Condition averaging is common bear market advice, but it must be done correctly to be effective.
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