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When I last wrote about “Averaging In” the FTSE100 was in the midst of a 16% Aug-Dec decline towards Christmas lows. This time, I hope the current 4.5% sell-off is a mere correction within 2019’s recovery rally (15% so far). So I hope we’re close to the bottom. Because we all want to buy at the lows, to profit from the next up-move.
What’s this about Joe? Let’s say he has a share position which is in the red. But he honestly believes it will recover to break-even, perhaps even its once profitable situation. He’d be right to hold on, if that’s what he really believes.
On the flip-side, if he’s only holding on because it might recover, he has to agree it might also get worse. Prepared to take that risk? He could say “I’ve already lost 50%, who cares?” I counter this with “If not convinced, why keep the position? Why not close it, preserve the remaining 50% and put it to better work elsewhere?”
Furthermore, if he believes that strongly in a recovery, he must also acknowledge that declines are only offset by bigger rises. Because you’re starting from a lower base. A 10% fall requires an 11% recovery; 20% fall, 25% rise; 30% drop, 42% rally; 40% slide, 66% climb. And so on. Losing positions must work harder to reach break-even, never mind profit.
So if Joe believes in the recovery, why not buy more at this lower price? Not only would it capture any recovery in full, itwould also lower his average entry price. This means he could exit his positions at breakeven even earlier than the original entry price.
Example: If you buy 10,000 shares at 100p (a £10,000 trade) and the shares fall by 30%, you now own 10,000 shares worth 70p or £7000. To get back to breakeven the shares now need to rally 43% (not 30%) to get back to 100p.
This is commonly used by traders to profit from belief in share price recovery. It reduces the distance shares need to rally in order to get back to break-even, or even into profit.
This does involve taking more risk, putting more money into the shares. But if you’re hanging on to a losing position, adamant about a recovery, what are you worried about? Unless you’re not that convinced, merely hoping. If that’s the case, may I direct you back to paragraph 3.
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Have a nice weekend.
Mike van Dulken, Head of Research, 10 May 2019
This research is produced by Accendo Markets Limited. Research produced and disseminated by Accendo Markets is classified as non-independent research, and is therefore a marketing communication. This investment research has not been prepared in accordance with legal requirements designed to promote its independence and it is not subject to the prohibition on dealing ahead of the dissemination of investment research. This research does not constitute a personal recommendation or offer to enter into a transaction or an investment, and is produced and distributed for information purposes only.
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