How to interpret Market Behaviour?

HOW TO INTERPRET MARKET BEHAVIOR

Whether you are an existing investor who holds a portfolio of shares or a beginner trying to enter the market, it is important for you to understand how the market behaves and where it is heading. The overall market health has a direct impact on a company’s profitability and almost all shares are impacted by the market sentiment, to a certain extent. Therefore, in order to be successful in stock investing, you must at least know how to recognise the major market trends.

What is a bull market?
A bull market refers to a stock market that is on the rise. It is considered as a bull market when almost all stocks are appreciating in value for a considerable period of time, usually with a price gain of over 20%. You will know that it is a bull market when everyone seems to be talking about buying shares and nobody seems to want to sell. This is when you observe that the demand for the shares is very strong resulting in limited supply, which in turn, pushes the shares prices even higher as investors are competing for the shares. During a bull market, investors are confident that the uptrend will continue into a longer term and the overall economy outlook is favourable while the employment rate is high. This is the time when everyone is exhilarated about the stock market as their chances of losing money in such market is quite low.

What is a bear market then?
A bear market is the total opposite of a bull market. It is characterised by a market that is downward trending with the stock value being depreciated by more than 20%. During a bear market, the demand for stocks is low while supply is high because everybody is trying to sell and only a few want to buy as the price continues to dip further. In such a market, the chances of losing money are high and therefore, you will see that the market sentiment is very pessimistic. A bear market is usually associated with weak economic outlook and the likelihood of declining company performance.

A typical bull market usually starts at the bottom, when the economy seems to be weak, such as during a recession. Here, you can observe governments trying to take certain measures like lowering interest rates to boost their economic recovery. When the market liquidity eases and company borrowing cost is lower, company profitability will improve and this in turn will indicate a positive sign for a bullish market to start.

On the other hand, when the market seems to be very hot with widespread bullishness, especially when the economic growth rate is high, coupled with high inflation rate, usually these signs signify a market top. This would indicate that there is a potential end of a bull market and the beginning of a bear market. During this period, investors should pay more attention to bad corporate news and warning signs to prepare for the turn in cycle.

How do these markets affect investors? 
Investor would ideally buy when the bull market is just about to start. This is when the stocks are still cheap and riding the bull wave until it reaches the top, before being sold as to maximise profit. Unfortunately, no one can be certain as to when the market is going to reach the top or the bottom. Therefore, by understanding how the market behaves, investors would have an idea on where the market is heading so that they can prepare themselves to take the necessary action. For example, an investor may not catch the stocks at the very bottom of the market, but at least he or she would know that the market is on its way to recovery and as such would start to pick up stocks with sound fundamentals but are still undervalue to invest in. Then, they would wait for the price to come up. Relatively, investing in a bull market is easier as the chances of making losses are low compared to investing in a bear market.

There are a few strategies that investors may take when dealing with a bear market. 

-  The most conservative way adopted would be to move out from stocks and invest in fixed income securities until the market recovers. 

-  Some would turn to the defensive stocks, such as those in the industries that are less affected by economic downturn, for example, food or utilities industries. 

-     The third option that is viable for investors is buying as the market continues to drop further to capitalize on the price reduction. However, investors who adopt this option face the risk of having their cash drying up all before the market reaches the bottom.

What is most important for investors to take note of when making investing decisions is the need  for homework; they need to do their homework properly, be it on the company itself or the overall economic situation. This is to ensure that their investment risk is minimised.

http://www.min.com.my/index.php?option=com_content&view=article&id=79

Connecting Crashes, Corrections And Capitulation

Connecting Crashes, Corrections And Capitulation

Posted: Jul 30, 2010

James Hyerczyk

Investors and traders face many obstacles in their quest for profits. Throughout even the longest uptrends, investors experience declines against the main trend. These are referred to as corrections. At other times, markets correct more than expected in a short period of time. Such occurrences are called crashes. Both of these can lead to a misunderstood situation called capitulation. We’ll look at these three concepts, their connections and what they mean for investors. (To learn more about market direction, read Which Direction Is The Market Heading?)

Wall Street’s White Flag
In stark terms, capitulation refers to market participants' final surrender to hard times and, consequently, the beginning of a market recovery. For most investors, capitulation means being so beaten down that they will sell at any price. True capitulation, however, doesn’t occur until the selling ends.

When panic selling stops, the remaining investors tend to be bottom fishers and traders who are holding on for a rise. This is when the price drop flattens into a bottom. One problem with calling the bottom is that it can only be accurately identified in hindsight. In fact, many traders and value investors have been caught buying into false bottoms only to watch the price continue to plunge - the so-called falling knife trap. (Traders can try to trade this phenomenon. Check out Catching A Falling Knife: Picking Intraday Turning Points for more.)

Capitulation or Correction?
When and where a market should bottom is a matter of opinion. To long-term investors, the series of retracements inside of a long-term uptrend are referred to as corrections in a bull market. A bottom is formed after each correction. Each time the market forms a bottom in an uptrend, the majority of investors do not consider it capitulation, but a corrective break to a price area where investors want to reestablish their long positions in the direction of the uptrend. Simply put, early buyers take profits, pushing the stock low enough to be a value buy again.

An investor can tell a correction from capitulation only after the trend has turned down and the downward break has exceeded the projected support levels and established a new bottom from which to trend up again. The question should not be whether capitulation is taking place, but whether the market has, in fact, bottomed.

Connecting to Crashes
A crash is a sharp, sudden decline that exceeds previous downside price action. This excessive break can be defined in real dollars as a market percentage or by volatility measures, but a crash typically involves an index losing at least 20% of its value. (To learn more, read The Crash of 1929 – Could It Happen Again?)

A crash is distinct from capitulation in two important ways. First, the crash leads to capitulation, but the time frame of the actual crash doesn’t necessarily mean capitulation will follow immediately. A market may hit capitulation – and the bottom – months after the initial crash. Second, a crash will always end in capitulation, but not all capitulations are preceded by a market crash.

In the long view, a crash occurs when there are substantially more sellers than buyers; the market falls until the there are no more sellers. For this reason, crashes are most often associated with panic selling. Sudden bearish news or margin call liquidations contribute to the severity a crash. Crashes usually occur in the midst of a downtrend after old bottoms are broken as both short sales and stop-loss orders are triggered, sending the market sharply lower. Capitulation is what comes next. (Learn more about buying on margin and margin calls in our Margin Tutorial.)

Finding the Bottom
A bottom can occur in two ways. Short selling can cease or a large buyer can emerge. Short sellers often quit shorting stocks when the market reaches historical lows or a value area they have identified as an exit point. When buyers see that the shorting has stopped, they start chasing the rising offers, thereby increasing a stock's price. As the price begins to increase, the remaining shorts start to cover. It is this short covering that essentially forms the bottom that precedes an upward rally.

As mentioned, the emergence of a large buy order can also spook shorts out of the market. It is not until the trend turns up, however, that one can truly say that buyers have emerged and capitulation has taken place. Large buyers occasionally try to move the market against the fundamental trends for a variety of reasons, but, like Sisyphus and his boulder, their efforts will fail if the timing is wrong. In timing capitulation, investors have to choose between going long on a rally started by short-covering or getting back in when actual buying – and the bottom – has been established. (For more, see Profit From Panic Selling.)

Catching the Turning of the Trend
Technical analysis can help determine capitulation because subtle changes in technical indicators such as volume are often heavily correlated with bottoms. A surge in volume is an indicator of a possible bottom in the stock market, while a drop in open interest is used in the commodity markets. Trend indicators such as moving average crossovers or swing chart breakouts are ways that chart patterns can help identify when a bottom or a change in trend has taken place.

Tricky Terminology
Crashes and capitulations are most often associated with equities, and the language is slippery. If we use percentage moves to determine whether a crash or capitulation has taken place in the stock market, then why is a downward move of over 20% in the commodities market always called a correction rather than a crash?

Moreover, one market event can also act as a crash, correction and capitulation. For example, a gradual break from 14,000 in the Dow Jones to 7,000 can be called a 50% correction of the top, but if the market drops the last 2,000 points in a short period of time, it will be called a crash. If the Dow then makes a bottom at 7,000, it will be called capitulation.

Real-World Crashes and Capitulations
Good historical examples are the Black Mondays of 1929 and 1987. In both cases, investors ran for the exits, producing big market drops. In 1929, the drop was prolonged as bad economic policies aggravated the situation and created a depression that lasted until World War II. The crash occurred in 1929, capitulation occurred in 1932, and then the actual rally occurred despite the economic conditions at the time. (For more, see What Caused The Great Depression?)

In 1987, the drop was painful, but stocks started to climb within the next few days and continued until March 2000. Surprisingly, the sudden drop in the stock market in October 1987 was called neither a capitulation nor a crash. Other euphemisms such as "correction" were used at the time. While some people realized what had occurred, it took the media years to label the event correctly. (For related reading, check out October: The Month Of Market Crashes?)

Bottom Line
After studying price movement, one can conclude that crashes and capitulation are parts of the same process. When a bottom occurs, traders can buy into the uptrend and watch the new support and resistance zones form as they navigate the rally until the next downtrend. So for them, it represents an opportunity. Long-term investors can also benefit from capitulation by getting into value stocks at extremely low prices. So, even though crashes, corrections and capitulations are bad news for investors holding the stock, there are still ways to profit. (Should you get out of a stock after a drop? Read When To Sell Stocks and To Sell Or Not To Sell for more.)

by James Hyerczyk
James A. Hyerczyk is a registered commodity trading advisor with the National Futures Association. Hyerczyk has been actively involved in the futures markets since 1982 and has worked in various capacities within the futures industry, ranging from technical analyst to commodity trading advisor. Using Gann theory as his core methodology, Hyerczyk incorporates combinations of pattern, price and time to develop his daily, weekly and monthly analysis. Hyerczyk is a member of the Markets Technicians Association and holds a master's degree in financial markets and trading from the Illinois Institute of Technology.


Read more: http://www.investopedia.com/articles/analyst/080702.asp#ixzz1ZzbPyTOR

Real returns with smart investment strategies

Real returns with smart investment strategies
Posted on November 27, 2010, Saturday

SEE your nest egg flourish with smart investing. It’s all about how much you invest and how often.

Successful investing is not about taking big risks, but more about being able to balance risk and return by investing in a meaningful portfolio.

Use investment strategies that do work: a balanced allocation of your portfolio’s assets among securities that suit your individual needs, the use of Cost Averaging (CA) to lower the cost of overall investments and dividend reinvestment programmes, and a well disciplined, long haul approach to investing.

Most important factor you have in reaching your goals is time. The more time you have, the more chance you have of success. If you’re thinking of embarking on an investment strategy like CA, know your facts first.

For example, CA involves the regular purchase of units in a managed fund or shares over a period of time. It can be done automatically via an investment plan and you may reduce the risk associated with market fluctuations while giving your portfolio the best chance of long term profitability.

Here are options for you to choose from when it comes to investing in your future:

1.Direct investing

You invest directly in the share market, property or real estate investment trusts (REITs). The downside is that it generally requires market knowledge, plus regular monitoring of market trends, tax and legal changes. Many working adults don’t have access to the right market information or expertise to do direct investing well.

2.Buying bonds

The general principle of bond investing is that when you buy a bond, you are lending your money for a certain period of time to the issuer, be it a listed company or not. It’s a good choice for investors who require fixed horizon and steady income.

However, investing in bonds are usually for the high- net-worth and institutional investors as bonds are usually offered at a high entry cost, in hundreds of thousands or millions of ringgit.

Additionally, investors are advised to pay attention to total return, not just yield as bond prices fall when interest rates rise. An option for the retail investors to access the asset class will be to invest in unit trust bond fund due to its low entry cost and diverse holdings which allows for diversification.

3.Stocks/equities

Historically the best, but most volatile way to grow your money is through the stock market. On a short-term basis, stock prices fluctuate based on everything from interest rates to investor sentiment, to the weather. But on a long term basis, you could potentially make (or lose) a lot of your money in stock market. Bear in mind that risk and return come hand-in-hand.

4.Managed funds

If you only have a small sum to invest, a good option is to put your money in a managed or unit trust fund. These are funds which pool the investments from a number of investors, enable you to access markets and assets that may be expensive or difficult to buy directly into, such as the China’s restrictive A-share market, emerging markets and even the fixed income space such as government bonds.

Additionally, unit trust funds are a good alternative to buying individual stocks, where in exchange for a small fee you will have the advantage of participating in several stocks within a fund. What happens is that the fund manager trades the fund’s underlying securities, realising capital gains or losses, and collects the dividend or interest income. The proceeds are then passed along to the individual investors. Most funds require only moderate investments, ranging from a few hundred to a few thousand Ringgit.

This article is brought to you by HwangDBS Investment Management, your Asian Financial Specialists. Log on to www.hdbsim.com.my or call 1-800-88-7080 to find out how you can cost average your investment via the HwangDBS Smart Save Plan.

http://www.theborneopost.com/?p=77325

Steady investments can beat the market by a mile

4 NOV, 2010, 01.31AM IST,
AMAR PANDIT,

Steady investments can beat the market by a mile

Guessing the index seems to be like an exciting pastime for most investors. They look at the index as some sacrosanct indicator to decide whether they should buy a stock.

“Sensex is back to 20000 and I feel something wrong is going to happen again,” said one learned acquaintance. “The markets are overvalued and I will invest when it corrects,” said another gentleman who did not even invest when the market was at 8000, thinking it will go down to 6000.

I asked many people who have been investing since 2005, “Do you remember the index levels in the year 2005?” Almost everyone replied in the negative. In 2005, the Sensex was between 6103 and 9397. I remember in 2005 a lot of people called even 6600 as a high level. One client had even said, “Let’s wait till 5000.” But guess what: he does not even recall the 2005 level remotely. This is because people have made fantastic returns over five years and it’s no longer important whether you invested at 6500 or 7000 or at 7500.

Here is why index levels should not be a real determinant of your investing decision: A difference between the lowest level every year and a fixed level every year over a long time frame does not matter at all.

Consider three different scenarios of index: 8000 in 2009, 13500+ in June 2009 and 18000 levels in August 2010.

1. Let’s say you started investing in 1991, when liberalisation in India started. If you managed the feat of investing at the lowest level every year since 1991, your annual returns would have been 15.88% CAGR as of June 1, 2009 at 13500+ levels. 
2. On the other hand, if you invested at the highest level every year, your returns would have been 11.78% CAGR. 
3. Now, if you had invested on a fixed date every year, let’s say, January 1, then your returns would have been a surprisingly 15.77%. 
4. The difference between a fixed date and the lowest date is just 0.11% pa.

Since 1991, the CAGR as on March 9, 2009,

• for annual investments made at the highest Sensex levels was 8.21%, 
• while it was 12.18% when the investments were made at the lowest levels. 
• For investments made on January 1 every year, it was 12.08%.

Similarly, since 1980, the CAGR as in August, 2010,

• for annual investments made at the highest Sensex levels was 16.19%, 
• while it was 17.60% when the investments were made at the lowest levels. 
• For investments made on January 1 every year, it was 16.91%.

Think for a moment. Does the paltry difference in returns between the lowest levels and regular investments really matter to you? For most equity investors, the answer will be a resounding no.

http://economictimes.indiatimes.com/personal-finance/savings-centre/analysis/Steady-investments-can-beat-the-market-by-a-mile/articleshow/6868486.cms

Dollar-cost averaging: The bear market solution investment strategy

With the stock market down 52% from its recent peak in October 2007, maintaining dollar-cost-averaging through the bear market proved to be worthwhile. By buying more shares at lower prices throughout the equity market downturn, an investor was able to reap bigger gains when the market recovered."






https://news.fidelity.com/news/article.jhtml?guid=/FidelityNewsPage/pages/mare-dollar-cost-averaging&topic=investing-stocks

Strategy during crisis investment: Revisiting the recent 2008 bear market

Although we may not know where the bear bottom is, buying in a down market may still lead to losing money. This is definitely true. As long as the purchase is not at market bottom, it may still result in losses for the time being. This is likely to be a short-term loss but compensated by a probable long-term gain. Even if we cannot time the market perfectly, we are definitely better off to “buy low and sell high” then to “buy high and sell low”.

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Prices fell but value intact

Presently stock prices have fallen sharply. 

• Banks are trading at 1x book value, 
• property stocks sold at 50% discount from net asset value, 
• utility stocks trading at single-digit price-earnings ratio providing an earnings yield of more than 10% net of tax and 
• there are many good stocks trading at dividend yield of 2x bank interest rates. 

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Warren Buffett, the second richest man in the world who makes his fortune from stock investment, is busy buying undervalued companies. He sees the value and he also sees prices detaching away from the intrinsic values. He said: “I haven’t the faintest idea as to whether stocks will be higher or lower a month — or a year — from now. What is likely, however, is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turn up.”  

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Catching a falling knife

Some may argue that buying now is like catching a falling knife. If you are not careful, you may be hurt and suffer more losses from falling stock prices. There is no doubt that we may incur short-term losses as long as we do not buy at the bottom. On the other hand, who can determine where and when is the bottom. As long as there are still unknown events or hidden problems, an apparent bottom now may not be the eventual bottom. Since we do not have all the information in the market, it is almost impossible to guess where the bottom will be.

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In most cases, we only realise the bottom after it is over and by that time stock prices are running high with much improved market confidence. Market bottom could be there only for a short period. In most cases, market did not stay at the bottom waiting for investors. It will just move on.

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Since market moves ahead of the economy by about six months, the market bottoms out when the economy is still gloomy, news are still negative, analysts are still calling underweights and most investors are staying at the sidelines. 

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Handling something we know is definitely much easier than dealing with the unknown risks, something which hits from behind without warning. When we invest during a crisis we actually go in with our eyes open. We know it is definitely risky but we also know it could also be very profitable. If we can handle the risk, the risk-reward trade-off will be very rewarding.

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Emphasise strategies

What we need is to buy near the bottom, not right at the bottom. Investors’ frequent question now is when to buy, that is where is the bottom? Perhaps it is more intelligent to ask how much to buy now since nobody will be able to guess where is the market bottom.

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Staggered buying is preferred over bullet purchase which is taking the risk of timing the market bottom. In staggered buying, a pre-determined amount will be set aside for investment over time, say in 10 equal portions.

One common method of staggered investment is dollar cost averaging, an investment scheme made in equal portions periodically, either by a small amount monthly or larger amount quarterly. There are also several variations of staggered investment.

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Anyway, staggered purchase is a preferred method to avoid the anxiety of market timing and the mixed feeling of fear of further downside and worry of missing the market rebound. As long as the market is undervalued, the strategy of staggered investment ensures that investors are in and are benefiting from the undervalued market. 

http://klsecounters.blogspot.com/2008/11/strategy-during-crisis-investment.html    

Good strategies for buying in and for preventing big losses

Strategies for buying in:

• Lump sum investing
• Dollar cost averaging
• Phasing in

Strategies for preventing big losses:

• Stop loss strategy
• Rebalancing

Dollar cost averaging and phasing in strategies are useful for those who wish to reduce the risks associated with market timing. 

Regardless of the buying in strategies (lump sum, dollar cost averaging or phasing in), acquisitions should only be done when the stock is available at bargain price or fair price, and certainly never when it is overpriced.

Stop-loss maybe unnecessary for some or many investors if the other risk management ideas are followed.

Value investors with a long term investing time horizon rarely need to use stop loss strategy.   In fact, the drop in price offers an opportunity for the value investor to reduce his cost per share.  This is safe provided he has not made a mistake in his initial assessment of the quality, value and management (QVM) of the stock.

Rebalancing at regular or fixed intervals can be usefully employed to bring his equity portion to a previously determined set proportion of his asset allocations in his portfolio.  This is particularly useful for those who are unable to take big risks (big losses: real or missed profit losses) during the bear or bull markets.

Though theoretically attractive, to be able to profit through rebalancing, near the peak of the bull or near the depth of the bear market, assumes one has the ability to predict (time) the market consistently.  This is of course not possible.

Always keep in perspective the 3 personal factors that are very important in your investing:  time horizon, risk tolerance and investing objectives.

Reviewing the basics of getting my timing right

If your time horizon, risk tolerance profile and investment objectives remain unchanged,

• it is better not to change your investment portfolio in times of uncertainty, when it may be a temptation to consider selling investments and reinvesting when prices are lower. 
• This technique is known as market timing and is a high-risk strategy simply because nobody knows what the future holds.

Patient investors will be rewarded:  research has shown that missing out on the performance of the stock market for only a few days could have a significant effect on performance.

The techniques of dollar cost averaging and phasing in can be preferable to market timing.

Two techniques for Getting your timing right: 'dollar cost averaging' and 'phasing in' your investments

Experience has shown that investors can benefit from being patient.  Impatience is your big enemy. 

Too often investors panic and sell their shares and equity unit trusts at a low, which could result in substantial losses.

There are two techniques:

• dollar cost averaging, and
• phasing in

which can diminish the negative impact of buying and selling at the wrong times.


Dollar cost averaging

Those who continue investing at regular intervals in the expectation that the market will recover, benefit from dollar cost averaging.

Dollar cost averaging can be used to great effect with unit trusts, because as you buy more units for the same amount as prices fall (or fewere units as prices rise), you will ultimately pay a lower average price for your units.


Phasing in your investments

In times of uncertainty new unit trust investors are faced with a tough choice: 

• should they invest a lump sum, or
• should they phase in their investment over a period? 

They have two possibilities:

A lump-sum investment can be made in

• unit trusts with a large cash element,
• a share component that does not correlate with the general direction of the stock market, and
• a portfolio manager who does not hesitate to take action.

Phasing in:  Prudent or less experienced investors can consider

• phasing in their investments over some months,
• potentially benefiting from lower prices because of downward reactions.

Short-term gain, long-term pain

Just reviewing my transactions in one of my stocks which I have invested since the 1990s. This review starts from May 2006.

The bought and sold transactions since May 2006

15-May-06 xx Bought at 3.98 Present price 8.35 Gain 4.370
31-May-06 xx Bought at 4.06 Present price 8.35 Gain 4.290
13-Jun-06 xx Bought at 3.92 Present price 8.35 Gain 4.430
26-Mar-07 xx Bought at 5.75 Present price 8.35 Gain 2.600
29-Mar-07 xx Bought at 5.95 Present price 8.35 Gain 2.400
03-Jun-07 xx Sold some at 5.3
28-Aug-07 xx Bought at 8.25 Present price 8.35 Gain 0.100
28-Jan-08 xx Sold some at 8.05
06-May-09 xx Bought at 7.70 Present price 8.35 Gain 0.650
05-Jun-09 xx Bought at 7.95 Present price 8.35 Gain 0.400

Stock xxx Avg Price --- Present price 8.35 Gain ---

The present price of this stock is 8.35.

The annual dividend yield of this stock is better than the present FD rate.

Its share price peaked at 9.25 in second half of 2007.

During the severe 2007 - 2008 bear market, the share price was at the lowest of $6.30 in September 2008.



Observations:

There were 10 transactions: 10 buys and 2 sells (partial).

Buying this stock at regular intervals has been profitable.

The prices of the stock bought in the early years were lower than those bought in the later years.

The share price of this stock (good quality company) has reflected its eps and eps growth rate over time.

At the lowest share price of $6.30, the average price of all the transactions were still lower than this market price.

Some stocks were sold for various reasons (e.g. to lock in gains/ or in anticipation of market downturn/ asset allocation/ etc.) in Jun 07 and Jan 08 for 5.30 and 8.05. The present price of this stock at 8.35 is higher than these selling prices.


DISCUSSION:

1. Buying this stock for the long term is safe and profitable.

2. Short term volatilities offer opportunities to buy this stock at bargain prices.

3. The above buying is almost akin to dollar cost averaging (upwards) and it is safe. Dollar cost averaging (downwards) is also safe and probably can give even better returns.

4. Selling this stock at anytime during the 2007-2009 severe bear market and not reinvesting into the same stock at lower prices, gives a lower return than the investor who held onto his stocks during the same period.

5. Lump sum investing into this stock at bargain prices in the earlier years, may give a better return, than dollar cost averaging the same amount over a very long time frame. Dollar cost averaging over a few months (for example 6 months) is almost equivalent to lump sum investing.

6. Timing the market is difficult. Study the above transactions:

• Did this investor buy during the depth of the 2007 - 2009 severe bear market? (This investor has to put in more work on this topic!)
• Did this investor sell at the height of the bull market?

7. In the transactions above, ''buy and hold' strategy can be likened as short term pain for long term gain. In the transactions above, 'buy, sell, and buy back at higher price', can be likened to short term gain for long term pain. ;-)

8. The average price of all the above transactions were significantly lower than the market price almost all the time. This is so even when the market price was at its lowest of $6.30. This gain provides a significant buffer and confidence to the investor of this stock. A value investor would be happy to hold or even load up on this share at the low prices.


CONCLUSION:
It is safe and profitable to buy and hold this and selective stocks.

Selective stocks can be held safely for the long term, even in a severe bear market.

Selling a good quality stock for short-term gain, generates cash which will need to be reinvested. This is not without its associated risks, including, that of not achieving your objective of superior gains in your investments (for example, 15% per year, doubling in 5 years).

Timing the market to buy and to sell is tempting, but is difficult. (trust me on this).

Selling and buying incurs some costs, and when are done frequently, will reduce your returns.

Dollar Cost Averaging vs Simple Averaging

There is a difference between simple averaging and dollar cost averaging.

Tan Teng Boo averaged down on a stock and profited. Let us look at what he did.

This was taken from this week's icap newsletter:
"A stock that the i Capital Global Fund invested in plunged around 85% during the 2007-2009 bear market. However, instead of selling as it dropped, we bought so much more of this stock that the cost price plunged around 80% too. By now, the i Capital Global Fund is sitting on a gain of 175% on this particular stock. The reason why ICGF bought so much more was because if it was attractive at higher prices, it is even more attractive at depressed prices since the business fundamentals of the company have not changed. "

What ICGF did. http://spreadsheets.google.com/pub?key=r_MxUHLmwJhsKRpR7JklS1Q&output=html

Simple Averaging

The first point to clear up is actually the difference between dollar cost averaging and simple averaging. What Teng Boo did above was not DCA but simple averaging.

Buffett does not believe in DCA. "It does not make sense investing in stocks when the prices are high." However, Buffett will employ simple averaging, often buying a good stock he likes in large amount when its price is down for no good reasons.

DCA

Those employing DCA should learn its limitations too. It is a way to diversify risk, and is definitely not a strategy to optimise your returns. Various studies quoted that returns from lump sum investing beats those from DCA, 60% of the time.

There are risks too from DCA. If the stock price tanked due to deterioration in its fundamentals, using DCA equates to throwing good money after a lousy company and should not be employed. Also, remember that the same amount used for DCA into a stock is an opportunity cost, to investing in another stock.


The Only Reason to Simple Average or Dollar Cost Average

I did pick up a very important point. It was good to see this advice in print. For those who are investing in good high quality stocks, averaging down can be employed in ONE particular situation, when its price tanked for no good reasons. However, there is still the need to ensure that your good high quality stock's fundamentals have not deteriorated.



To summarise:

There is only one reason that justifies simple averaging or dollar cost averaging - when its price tanked for no good reasons. However, there is still the need to ensure that your good high quality stock's fundamentals have not deteriorated.

If you thought that a stock was undervalued at $34 and without the fundamentals of the company changing, the stock got unfairly beaten down.

An investor put it: "The company and its business have not changed. The only change is its share price got beaten down."

Risks of Dollar Cost Averaging

Risks of Dollar Cost Averaging
by Jim Wang Print Article Email Article Share on Facebook

This is more like a mini-Devil’s Advocate post because of the nature of the idea of dollar cost averaging. Dollar cost averaging isn’t a strategy that is meant to guarantee with any sort of high probability that you’ll generate profits from the stock market, it’s meant as a risk mitigation strategy to help weather the volatility of the stock market. That being said, some people believe that by using dollar cost averaging you can get better returns, which is incorrect and that’s the idea I’ll be tackling today.

The idea behind dollar cost averaging is that you buy smaller lots of a stock until you build up the amount that you truly want, getting a nice average purchase price that isn’t at either the peak or the valley of your period. The stock market is volatile on a daily basis but increasing in the long run so by spreading out your buys you are smoothing out the curve. Proponents advise this because you won’t run the risk of buying your whole lot at a peak thus lowering your total risk involved. This is by no means a guarantee that you’ll generate profits, just that you didn’t pay the maximum price for the share in the period you were acquiring. Now the problem comes when people believe that this means DCA is a strategy for higher returns… it’s not and here’s why.

No Peaks But No Valleys Either
Just as how you didn’t buy your shares at the peak in its price, you also didn’t buy it at its lows either. If you bought one round lot (100 shares) at 10AM, one at 1PM, and one at 3PM, you probably paid three different prices for those three hundred shares and that, of course, guarantees that your average price paid is neither the peak or the valley of the stock during that period of time. If the stock was moving upwards, you paid the least in the morning and the most in the afternoon - which was more than if you bought all three hundred shares at 10AM in the first place. Now, if the stock was falling, you saved yourself the heartache as well but there is no guarantee either way.

Multiples Buys Means Multiple Commissions
Hmmm… who is recommending that you use dollar cost averaging? Could it be the folks who stand to benefit from more trades? If you make three buy orders, you generate three times the fees and commissions than if you made only one buy order! No wonder they recommend dollar cost averaging, it means more money in their pockets.

Lots of Effort
I don’t know of many brokerages, short of something like Sharebuilder where you’re paying a premium otherwise, where you can schedule purchases by time rather than by price (limit orders) and so in order to do dollar cost averaging, you’re going to have to execute those trades pretty much manually, which quit a bit of effort (at least more than making one buy).

So remember, dollar cost averaging isn’t a trading methodology that can guarantee that you earn money, it’s only a way of smoothing out your risk. Once you remember that, dollar cost averaging isn’t all that bad if you’re willing to do the legwork.

The Pitfalls of Dollar Cost Averaging

For example:

I bought 100 shares of Microsoft at $34.00 a year ago, making my investment in Microsoft $3,400 (100 shares @ 34 = $3,400).

Now, suppose today that the price of Microsoft is just $17.00 and I have $3,400 more to invest. I buy 200 additional shares, increasing my total holdings to 300 shares (200 shares @ 17 = $3,400).

Since my total investment is $6,800, my average purchase price is now only $22.67 (6800 / 300).

The Psychology of Dollar Cost Averaging

In our example, we would look at our Microsoft holdings (before dollar cost averaging), and say - this stocks needs to double its price before I can make any profit on it. However, after dollar cost averaging, the stock needs to go up just 5.67 per share before I start to make money. This is a very heartening feeling, and one I’ve done several times. However, if you are averaging just for this warm feeling, then you need to take a hard look at the opportunity costs.

Opportunity Costs of Dollar Cost Averaging

Opportunity cost is what you forgo in order to get something else (economists call it the value of the next best alternative).

For instance, if what I really wanted to do with my second $3,400 was buy Apple stock (trading at $80) instead of Microsoft, the opportunity cost of my decision is the Apple stock. Since $3,400 translates to about 42 Apple shares, the opportunity cost of 200 Microsoft shares is 42 Apple shares.

As long as both Apple and Microsoft grow at the same rate, it doesn’t make any difference to me. It is only when Apple appreciates quicker than Microsoft do I get affected. This is key because stocks that fall tremendously may not rise as much as the rest of the market. The very fact that they fell so much shows that something is wrong with them.

The Only Reason to Dollar Cost Average

There is only one reason that justifies dollar cost averaging.

If you thought that a stock was undervalued at $34 and without the fundamentals of the company changing, the stock got unfairly beaten down.


Should you Dollar Cost Average?

Next time you are tempted to buy more stock to bring the average cost down, ask yourself one thing. Am I doing this for a warm feeling or is the stock a steal at this price?

If you answer this question honestly, you will get it right much more often.



http://investing-school.com/myth/the-pitfalls-of-dollar-cost-averaging/

Dollar cost averaging: Bull versus Bear Markets

Dollar cost averaging: Bull versus Bear Markets

This examines the multiple benefits of dollar cost averaging as a long-term investment strategy.

There are two types of markets: "bull" markets and "bear" markets. Bull markets relate to those periods when the market is trending upwards.

Conversely, bear markets are flat or downward trending. In bear markets, the tendency for most investors is to stay on the sidelines and wait for signs of a market recovery before investing. This makes sense. After all, why invest in a market which is either falling or going nowhere?

The problem, however, is that it is very difficult - many say impossible - to determine when the next bull market is about to start. In fact, it is usually only after many months of excellent returns that a bear market is declared over and a bull market officially in play. As a result, most investors sit on the sidelines for too long and therefore miss out on the substantial gains made at the very start of a bull market.

So, if it is impossible to perfectly time your investment entry point, is it better to invest near the start of the bear market - or wait until after the next bull market begins?

The answer is neither.

Adopting a "dollar cost averaging" strategy during a bear market may be one way to avoid issues of market timing. This is where you invest the same amount of money on a regular basis over a number of years.

There are two performance benefits from this approach.

• Firstly, you are not putting all your money at risk should there be a large market fall early in a bear market.
• And secondly, you are assured that a portion of your money will participate in the early gains of the next bull market.

Here's how dollar cost averaging works.

http://www.zurich.com.au/zportal/cs/ContentServer?pagename=GroupSite/Page/ThreeColumn&cid=1233198359931&p=1159692288459

Lump-sum investing beats dollar cost averaging over 60% of the time

Dollar Cost Averaging versus Lump Sum Investing?

This question actually came up last year, but I didn’t research it very much. My own thoughts were that because the markets trend upwards overall, if you are investing for a long-term period you should get your money in as soon as possible. Sure, you might run into a huge drop, but you could just as easily (in fact more easily) miss a huge rise. But this is too hand-wavy, as scientists would say. I want numbers. So I found some.

Now, wouldn’t it be nice to have a comparison of DCA vs. lump-sum investing for the past 50+ years? We could compare investing $10,000 all at once in January of 19xx, versus using DCA equally over all 12 months of that year. Wouldn’t it be even nicer if we could take into account that any money not used be put in a high-yield interest bearing account?

Well MoneyChimp did just that all the way back to 1950. The result? I used 4.25% rate for bank interest, and over 60% of the time, lump-sum investing beat dollar cost averaging. This result of DCA losing out about 2/3rds of the time is supported by historical back-testing from 1926 in this article from the Financial Planning Association: ‘Lump Sum Beats Dollar-Cost Averaging‘. (Just read the conclusion if you get bored.)

Of course, past performance does not guarantee future results. And DCA would smooth things out if your time frame is really short. I think everyone should consider the facts above and make their own decision. But I bet with the odds, and the odds are that I should invest it as a lump-sum.

Dollar Cost Averaging for better or for worse

Dollar Cost Averaging and Market trend

Here’s the question: is this a good thing? Lots of financial advisors think that dollar cost averaging is the cat’s banana, but I’m not entirely convinced.

Uptrending market: Let’s look at a year in which the value of a stock starts at 100, goes up 10 a month until June (the peak), then stays steady for the rest of the year. You paid $134.94 per share with dollar cost averaging. If you instead bought in at the start of the year with your complete investment, then you paid only $100 per share.

Downtrending market: On the other hand, let’s look at the reverse market: the stock starts at 100, goes down 10 a month until June, then stays steady the rest of the year. If you invested it all right off the bat, you spent $100 a share for stocks now worth $50, but if you used dollar cost averaging on a monthly basis, you only paid an average of $58.66 per share.

Dollar cost averaging is good if you think there’s a good chance that the market will see turbulence or go down. It will reduce the impact of the collapse on your investing. On the other hand, dollar cost averaging doesn’t do so well if the market is going crazy.

Here is how one investor views dollar cost averaging: "Since I think the market is going to be turbulent, but not go up or down a whole lot overall in the year 20xx, I think that dollar cost averaging is fine for me in the short term."

http://www.thesimpledollar.com/2006/12/30/how-im-using-dollar-cost-averaging-for-better-or-for-worse/

Dollar Cost Averaging Stock Strategy

Stock Strategies
Dollar Cost Averaging Stock Strategy
by InvestorGuide Staff


Investors have three major concerns when buying stocks:

• making a profit on their investment,
• minimizing risk, and
• the actual rate of return they will receive (including any dividend income).

Ideally, there would be windfall profits in record time with no risk.

In the real world, investors must use stock strategies that match both their resources and skill level. The dollar cost averaging stock strategy is a great approach for people new to stock investing that minimizes risk and trends towards sound profitability - especially the longer it is used.

Basics of Dollar Cost Averaging

The dollar cost averaging stock strategy minimizes risk because it reduces the difference between the initial investment and the current market value over a long enough timeline. This is accomplished by making fixed investment amounts at predetermined times. Now this investment could be in a specific stock or perhaps even an index fund. The point is to remain committed to this investment for years and not to allow fluctuations in price to affect your buying strategy.

Knee jerk responses are common with stock investments, especially for beginners. One bad earnings report can send stock prices tumbling and cause investors to panic. This causes a sell-off that further lowers prices. But; if a person were to keep their stock and still continue buying at regular intervals, the average price of the stock should continually approach the current market value at the time of purchase at each interval. Temporary fluctuations in pricing should even out. While the stock price may be lower than the initial investment value, the ability to acquire more shares at a lower price means that the short-term decrease in average stock price should be balanced out when the share price increases. However, never confuse dollar price averaging with simple averaging.

For instance, let's say an investor purchased 1,000 shares of Microsoft stock at $40 per share at the first interval and another 1,000 shares of stock at the next for $25 a share. That would make the total investment $65,000 and the average stock price $32.50. However, this is not dollar cost averaging - it is simple averaging.

The average cost of the stock will not trend towards the current market value if you do not remain consistent in your investment strategy. Using dollar cost averaging, a person would invest a fixed amount - say $33,000 per interval. Thus, when buying the same Microsoft stock at the first interval, a person would end up with 825 shares of stock at $40/share and 1320 shares at $25 each. This adds up to 2,145 shares and an average cost of $30.75 - closer to the current market value of $25 than the simple averaging strategy.

From the example above, the one drawback to the dollar cost averaging strategy is revealed:

• while it reduces risk and lowers the difference between the average stock price and the current market value, it will not eliminate the possibility of a loss if the average price does not move fast enough.
• In fact, if an investor were to pick a stock that was on its way down and continued investing in regular intervals as advised by the dollar cost averaging strategy, the losses could add up rapidly.

While the investor may be buying more shares at each interval due to lower prices, having more shares of continually declining stock simply adds insult to injury. For this reason, an investor must have a cutoff point at which he/she ceases purchasing the stock at regular intervals. Fluctuations in market price can be absorbed and an investor can still make a healthy profit using the dollar cost averaging stock strategy but a declining stock is just a loser. Unfortunately, the dollar cost averaging strategy is most profitable on stocks that were underperforming at the time the investment plan was initiated. Therefore, the best stocks to make the most profits on are also the ones that are more likely to recover and continue trending upwards in share price. Prudent research is necessary before initiating any dollar averaging stock strategy.

Implementing a Dollar Cost Averaging Strategy

The very first step in planning to use this strategy is determining how much you can realistically afford to invest over an extended period of time. This is very important because the strategy will not reduce risk of loss effectively unless the investment amount is consistent. You will not insulate yourself against losses as effectively when a large initial investment is made and then followed by increasingly smaller amounts. In such a scenario, the gap between the average stock price and current market value will be larger and the risk for loss greater.

The next step in this or any other stock strategy should be to choose your investment carefully. Remember, you need to stay with this investment for many years for the strategy to be effective. An investor will get killed if they purchase an underperforming stock that does not recover. For this reason, combining the benefits of dollar cost averaging strategy with the diversification and reduced risk of an index fund is a prudent approach when choosing an investment.

An index fund is like a mutual fund in that it is designed to mimic the returns of prominent benchmarks such as the Dow Jones Industrial Average or the S&P 500. Investors own a fraction of each stock that makes up the index. The principle difference and benefit to investors in an index fund is that their management fees are a fraction of those charged for actively managed mutual funds. This is because index funds are passively managed. By combining the dollar cost averaging strategy with the increased diversification and reduced management/transaction fees of an index fund, an investor can maximize the profit potential and minimize risk.

Finally, pick an interval that you can be consistent with for years into the future. A weekly interval will work but it is probably best to make it monthly or even quarterly. Longer intervals are better because they reduce the expense of multiple transaction fees and also allow you to buy larger numbers of stock with each purchase.

Dollar cost averaging

Dollar cost averaging

From Wikipedia, the free encyclopedia


Dollar cost averaging is a timing strategy of investing equal dollar amounts regularly and periodically over specific time periods (such as $100 monthly) in a particular investment or portfolio.

• By doing so, more shares are purchased when prices are low and fewer shares are purchased when prices are high.
• The point of this is to lower the total average cost per share of the investment, giving the investor a lower overall cost for the shares purchased over time.

In dollar cost averaging, the investor decides on three parameters:

• the fixed amount of money invested each time, and
• investment frequency, and
• the time horizon over which all of the investments are made.

With a shorter time horizon, the strategy behaves more like lump sum investing.

One study has found that the best time horizons when investing in the stock market in terms of balancing return and risk have been 6 or 12 months.


Criticism of DCA Risk Reduction Theory

Pro: While some financial advisors such as Suze Orman claim that DCA reduces exposure to certain forms of Financial risk associated with making a single large purchase.
Con: Others such as Timothy Middleton claim DCA is nothing more than a marketing gimmick and not a sound investment strategy.

Pro: Others supporting the strategy suggest the aim of DCA is to invest a set amount; the same amount you would have had you invested a lump sum.
Con: Middleton claims that DCA is a way to gradually ease worried investors into a market, investing more over time than they might otherwise be willing to do all at once.

Studies of real market performance, models, and theoretical analysis of the strategy have shown that:

• DCA is associated with lower overall returns, and,
• DCA does not even meaningfully reduce risk when compared to other strategies, even including a completely random investment strategy.

(Buffett does not believe in dollar cost averaging. Why buy stocks when the prices are high? Buy when the stocks are offered at a bargain.. and always!)

How Bad Will It Get?

How Bad Will It Get?
By Tim Hanson October 9, 2008 Comments (74)

It's grim out there. The market is down 24% since the beginning of September. The financial contagion that started with the U.S. subprime mortgage defaults has spread to Europe and Asia. Fully 60% of Americans now believe that a depression -- replete with 25% unemployment and widespread homelessness and hunger -- is "likely." And just 9% of Americans, an all-time low, are satisfied with the way things are going in the country.
It's gotten so bad, in fact, that the Booyah Bull himself, Jim Cramer, told investors on Monday to pull any money they need for the next five years out of the market.

Now, that's not necessarily bad advice
Of course, you should never be investing the hard-earned dollars that you need to pay your bills over the next few years. But if you heed the wisdom of the late Sir John Templeton -- whom we recently eulogized as the world's most important investor -- you should always be ready, willing, and able to invest some of your long-term savings in common stocks at -- and this is crucial -- the point of maximum pessimism.
What can happen when you buy at the point of maximum pessimism? Well, as Sir John proved when he famously purchased 100 shares of 104 companies trading for $1 per share or less in 1939, as the market panicked at the outset of World War II, you can make a lot of money.
The good news for you today is that given that data presented above, we're getting pretty darn close to that point -- only 9% of Americans are left to be convinced.

An important caveat
This, however, does not mean that the market has bottomed. It could well get worse before it gets better, particularly since the credit markets remain frozen and home prices look like they have a bit more "rationalizing" to do.
But some stellar businesses are already selling at hefty discounts to the norm:

Company
Current P/E ....5-Year Average P/E

Microsoft (Nasdaq: MSFT)
12.3....25.1
Paychex (Nasdaq: PAYX)
17.9....35.3
Intel (Nasdaq: INTC)
13.4....24.4
Fastenal (Nasdaq: FAST)
20.9....33.9
Ritchie Bros. Auctioneers (NYSE: RBA)
27.2....31.2
Nike (NYSE: NKE)
15.3....20.0
Best Buy (NYSE: BBY)
12.1....22.4
Data from Morningstar.com.

Are you brave enough to start today?
Rather than try to time the market and catch these names on the way back up, start dollar-cost averaging into an array of superior names now (remember, Sir John purchased shares in 104 companies) with a commitment to holding shares for the next five years or more. That's the only time-tested way to turn current market volatility to your advantage, and the rewards will be great for those with the courage and resources to do so.
The key, though (and this bears repeating), is to average in -- keeping some money on the sidelines if the market continues to drop -- and adding new money, even in a small amounts, on a regular basis. That's a particularly prudent tack today, given the low costs of trading and the violent unpredictability of today's stock market.


Tim Hanson owns no shares of any company mentioned ... yet. The Motley Fool owns shares of Best Buy. Microsoft, Intel, and Best Buy are Motley Fool Inside Value recommendations. Best Buy is also a Stock Advisor pick. Paychex is an Income Investor selection.
Read/Post Comments (74)

http://www.fool.com/investing/general/2008/10/09/how-bad-will-it-get.aspx

**Averaging Down: Good Idea Or Big Mistake?

Investopedia

Averaging Down: Good Idea Or Big Mistake?

Friday December 19, 12:38 pm ET Elvis Picardo

The strategy of "averaging down", as the term implies, involves investing additional amounts in a financial instrument or asset if it declines significantly in price after the original investment is made. It's true that this action brings down the average cost of the instrument or asset, but will it lead to great returns or just to a larger share of a losing investment? Read on to find out.

Conflicting Opinions
There is radical difference of opinion among investors and traders about the viability of the averaging down strategy. Proponents of the strategy view averaging down as a cost-effective approach to wealth accumulation; opponents view it as a recipe for disaster.

The strategy is often favored by investors who have a long-term investment horizon and a contrarian approach to investing. A contrarian approach refers to a style of investing that is against, or contrary, to the prevailing investment trend.
For example, suppose that a long-term investor holds Widget Co. stock in his or her portfolio and believes that the outlook for Widget Co. is positive. This investor may be inclined to view a sharp decline in the stock as a buying opportunity, and probably also has the contrarian view that others are being unduly pessimistic about Widget Co.'s long-term prospects. Such investors justify their bargain-hunting by viewing a stock that has declined in price as being available at a discount to its intrinsic or fundamental value. "If you liked the stock at $50, you should love it at $40" is a mantra often quoted by these investors.
On the other side of the coin are the investors and traders who generally have shorter term investment horizons and view a stock decline as a portent of things to come. These investors are also likely to espouse trading in the direction of the prevailing trend, rather than against it. They may view buying into a stock decline as akin to trying to "catch a falling knife." Such investors and traders are more likely to rely on technical indicators, such as price momentum, to justify their investing actions. Using the example of Widget Co., a short-term trader who initially bought the stock at $50 may have a stop-loss on this trade at $45. If the stock trades below $45, the trader will sell the position in Widget Co. and crystallize the loss. Short-term traders generally do not believe in averaging their positions down, as they see this as throwing good money after bad.
Advantages of Averaging Down
The main advantage of averaging down is that an investor can bring down the average cost of a stock holding quite substantially. Assuming the stock turns around, this ensures a lower breakeven point for the stock position, and higher gains in dollar terms than would have been the case if the position was not averaged down.
In the previous example of Widget Co., by averaging down through the purchase of an additional 100 shares at $40, the investor brings down the breakeven point (or average price) of the position to $45. If Widget Co. stock trades at $49 in another six months, the investor now has a potential gain of $800 (despite the fact that the stock is still trading below the initial entry price of $50).
If Widget Co. continues to rise and advances to $55, the potential gains would be $2,000. By averaging down, the investor has effectively "doubled up" the Widget Co. position. Had the investor not averaged down when the stock declined to $40, the potential gain on the position (when the stock is at $55) would amount to only $500.
Disadvantages
Averaging down or doubling up works well when the stock eventually rebounds because it has the effect of magnifying gains, but if the stock continues to decline, losses are also magnified. In such cases, the investor may rue the decision to average down rather than either exiting the position or not adding to the initial holding.
Investors must therefore take the utmost care to correctly assess the risk profile of the stock being averaged down. While this is no easy feat at the best of times, it becomes an even more difficult task during frenzied bear markets such as that of 2008, when household names such as Fannie Mae, Freddie Mac, AIG and Lehman Brothers lost most of their market capitalization in a matter of months.
Another drawback of averaging down is that it may result in a higher-than-desired weighting of a stock or sector in an investment portfolio. As an example, consider the case of an investor who had a 25% weighting of U.S. bank stocks in a portfolio at the beginning of 2008. If the investor averaged down his or her bank holdings after the precipitous decline in most bank stocks that year so that these stocks made up 35% of the investor's total portfolio. This proportion may represent a higher degree of exposure to bank stocks than that desired, putting the investor at much higher risk.
Practical Applications
Some of the world's most astute investors, including Warren Buffett, have successfully used the averaging down strategy over the years. While the pockets of the average investor are nowhere near as deep as deep as Buffett's, averaging down can still be a viable strategy, albeit with a few caveats:
Averaging down should be done on a selective basis for specific stocks, rather than as a catch-all strategy for every stock in a portfolio. This strategy is best restricted to high-quality, blue-chip stocks where the risk of corporate bankruptcy is low. Blue chips that satisfy stringent criteria - which include a long-term track record, strong competitive position, very low or no debt, stable business, solid cash flows, and sound management - may be suitable candidates for averaging down.
Before averaging down a position, the company's fundamentals should be thoroughly assessed. The investor should ascertain whether a significant decline in a stock is only a temporary phenomenon, or a symptom of a deeper malaise. At a minimum, factors that need to be assessed are the company's competitive position, long-term earnings outlook, business stability and capital structure.
The strategy may be particularly suited to times when there is an inordinate amount of fear and panic in the markets, because panic liquidation may result in high-quality stocks being available at compelling valuations. For example, some of the biggest technology stocks were trading at bargain-basement levels in the summer of 2002, while U.S. and international bank stocks were on sale in the second half of 2008. The key, of course, is exercising prudent judgment in picking the stocks that are best positioned to survive the shakeout.
Conclusion
Averaging down is a viable investment strategy for stocks, mutual funds and exchange-traded funds. However, due care must be exercised in deciding which positions to average down. The strategy is best restricted to blue chips that satisfy stringent selection criteria such as a long-term track record, minimal debt and solid cash flows.

http://biz.yahoo.com/investopedia/081219/4101.html