The term is usually used in three contexts: as part of a dollar-cost averaging strategy; in trading, where it is referred to as “pyramiding”; and when making the decision to buy more stock in a position after a big stock price gain. Let’s go over how each works, then look at a few examples.
Definition and Examples of Averaging Up
When you buy more of a stock or other investment after the market price goes up, you’re averaging up. That is because the average price of your position goes up. In trading, one way of averaging up is called “pyramiding.” When you use a pyramiding trading strategy, you buy more of the security in decreasing increments as its price moves higher. The benefit of pyramiding is that you can buy more once the trade starts moving in your favor. This way, if you’ve made the wrong decision, you didn’t risk as much money. The risk to pyramiding is that if the trade does end up going against you fast, you lose even more money because your average purchase price is higher. Finally, for investors using dollar-cost averaging, when stock prices are going up, it is referred to as averaging up into a position. Dollar-cost averaging is the process of buying a set amount of a stock every period no matter what (most often a month, but this can also be done on a quarterly or annual basis). Unlike the other two instances, when you dollar-cost average, averaging up isn’t a conscious decision you’re making; it’s just what happened.
How Averaging Up Works
Let’s use Roku, Inc. (ROKU) to work through an example of averaging up for a growth stock investor and a dollar-cost averager. Let’s say you initiated a position in Roku soon after it debuted its IPO with 100 shares in 2017 for $52 per share. For the first year and a half or so, the stock price whipsawed a little, going as low as $30 per share and hitting $100 per share. In August 2019, the company reported strong quarterly results. Sales were up, revenue per user was up, and active accounts breached 30 million. So you decided to buy 100 more shares in September at $150 per share. A year later, the stock price recovered from the 2020 stock market crash, and Roku had another great second quarter marked by exceptional account growth. You bought 100 more shares at $177 per share in September. Here’s what your position looked like: Now let’s assume you dollar-cost averaged into the position over the year 2019. Here’s what the buys would have looked like:
Averaging Up vs. Averaging Down
The benefit of averaging down is that you’re reducing your average price. If the prices rises later and you’re eventually proven correct, you’ll have an even better gain than if you had just stuck with the initial investment. Traders believe in averaging up because prices going up can be seen as confirmation of their thesis. If you do decide to average down, make sure you reevaluate your thesis and confirm that it’s still valid.
