How to calculate the average price of a share to be profitable! Read on to find out more

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We always want to pay less and expect more. But in the stock market, no one is able to predict the fair price of a share and the level of returns. Very often it happens that a retail investor buys a stock at its highest price, guided by emotions or tips, and then continues to wait for the right price, for a reasonable exit.

An appropriate stock price averaging might be the answer to arrive at a rational stock price for better returns. However, an effective and beneficial average is a matter of good judgment. Otherwise, it could erode a stock’s value over the long term, especially in the case of fundamentally poor stocks. Thus, one must be careful when averaging the price of a stock.

Why do you need the average stock price

It is common knowledge that volatility and uncertainty are regular features of the stock market. Therefore, fluctuating security prices are a norm rather than an exception. It is also desirable to buy a stock at a reasonable price, with a long-term perspective. Quite often, we can buy a stock at its peak, out of emotion or fear of being left behind, taking advantage of the momentum and rising volumes of a stock, especially in the upswing of the market. Since the stock market is never one-way and changes direction without alarm, no one is able to predict whether a stock price will fall or rise.

Therefore, if we bought a stock at its highest price, but with a downward trend, its price would fall sharply. Then a sensible price averaging should help. That said, price averaging works best for fundamentally strong stocks, and not at all for weaker stocks.

It is common knowledge that the stock market is characterized by volatility and uncertainty. Therefore, stock price fluctuations are the norm rather than the exception.

The concept of average

Suppose you bought 100 units of a share at Rs 100 each, convinced of the fundamentals and its future prospects, but probably close to its peak price. Then it was subject to volatility and a downward trend, causing its market price to drop sharply.

At this point, revamp and reaffirm the quality of the stock and, if you’re happy, watch its price move and buy in smaller lots of one to three with each price drop, guided by the bottom-up approach.

So, maybe, let’s say you bought another 25 units at Rs 70; 25 units at Rs 60; and 50 other units at Rs 50 each. Then the total purchase cost would come to Rs. 10,000+ rupees. 1,750 + rupees. 1,500+ rupees. 2,500 = rupees. 15,750. The average price per unit would then be Rs. 78.75.

Alternatively, if you bought a stock at, say, 300 rupees per share, but its price steadily rises to over 400 rupees in a few sessions, then going through its consolidation around that price, suggesting it is promising, buy another batch and watch it grow and sell some for whatever price you see fit!

This way, your holding price will drop to a much safer level from a long-term perspective.

Factors governing the average stock price!

There are a few factors that govern the average price of a stock. They are:

1]Fundamentals of an action: Averaging only works for stocks that have strong fundamentals, belong to a favored sector of the market, and are well below their highest price level. Otherwise, for a fundamentally poor stock, it could add to its woes by becoming a liability with mounting losses.

2]Market volatility: When a fundamentally sound stock is in consolidation mode, price averaging may seem desirable, especially at the lower end of consolidation mode.

3]Futuristic trend: Any title presenting a futuristic tendency; for example, nowadays, the booming sectors of digitization, information technology, banking and financial services and the pharmaceutical industry are well suited to the average price.

4]Fix Bad Actions in Stock Picking: This marks the fundamental reason and the need for averaging, that is to say favorably minimizing the price of an asset. This implies that for a stock bought at its peak price, which fell rapidly with the trend reversal, the average could prove profitable.

Average Types

These are the means by which you could average your stock prices.

1]Systematic Investment Plan (SIP): This can be considered an automatic medium price mode. This involves regularly buying your favorite stock in small lots with each drop.

sip
Systematic Investment Plan (SIP)

2]Random average: Once you have purchased a relatively larger lot of shares and the market suddenly begins to plunge, seriously eroding the price of your holding, you will have two options. One, to record your loss and enter another better certificate; and second, if you believe in the value and promise of your actions, use an appropriate average.

3]Reckless Averaging: These could be stocks that you may have bought out of emotion or on an earned tip, i.e. a fundamentally weaker stock, or a stock that was sometimes a favorite, but which, in due to unfavorable market conditions, became a penny stock. In such a situation, the average would turn out to be harmful. It could be similar to carrying dead stock for a long time. For example, a stock like Yes Bank, which at one time was a blue chip stock, but is now very cheap. If one holds a fundamentally weak stock and is tempted to average due to an extremely low price, it could, in fact, prove very detrimental. Such a reckless purchase should be avoided.

The author is a former Indian government employee and worked in the agricultural sector.

Disclaimer: The opinions expressed are those of the authors and Outlook Money does not necessarily endorse them. Outlook Money will not be liable for damages caused to any person/organization directly or indirectly.

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