InvestorQ : What should a trader do if he buys a stock and it goes into downtrend?
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What should a trader do if he buys a stock and it goes into downtrend?

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diksha shah answered.
2 years ago


The most common dilemma of averaging is when you bought a stock and the stock goes down. The key question is whether the stock has gone into an intermediate downtrend. This has nothing to do with the quality of the stock or the quality of the management. Both these may be favorable and yet averaging may be the wrong choice. Consider the case of L&T in 2011. The capital cycle was turning down and investors suddenly realized that L&T will not be able to maintain its growth and margins to justify its valuations. The stock lost more than 50% over the next couple of years. When the underlying trend shifts, there is no point in averaging. Second is a case where something is changing fundamentally. Take the cases of IT and pharma over the last 18 months. Marquee names have lost over 50% value purely because the regulatory environment was getting tougher and margins were getting thinner. When there is such a fundamental change, you must avoid averaging your long position.
What about averaging your short position? Watch out if the stock is breaking out with higher volumes. In that case, averaging your short positions can be disastrous. Reliance in the last 8 months and Maruti in the last 18 months are classic cases in point. If you were short on either of these stocks, you would have ended up in huge losses by averaging your short positions.