Dollar cost averaging

There may be times when you are trading where things go sour and you are forced to make a decision. I wrote a little while ago about one of the options available at this point; to sell and move the cash into a better trade.

Other than simply holding on the share and waiting for it to recover, the third option is dollar cost averaging. This is an aggressive strategy that, when used effectively, can turn a bad trade into an good one. Dollar cost averaging (or DCA), in simple terms, is just buying more of the same share that you already hold, but at a lower price. This then lowers your average cost per share, meaning that even if you make a loss on some of that parcel, you can still make an overall profit because of the second purchase.

Another advantage of DCA (particularly in small volume trades) is that you only have to pay one extra lot of brokerage when buying at a lower price, as you can all your shares together and only pay one lot of brokerage on the sale. It all adds up.

The following example is a previous trade I executed some time ago in the share Rio Tinto. I bought 44 RIO shares at the price of $62. Unfortunately for me they then dropped quite a bit. I wasn’t too worried at the time as I was happy to keep my money in RIO for a time; it’s a quality stock. So I purchased another 44 shares at the price of $56.49. This made my total outlay including brokerage $5303.41 and an average gross purchase price of $60.26 (incl brokerage cost). Luckily RIO rebounded and I decided to sell them at $62 to get into another trade instead. Even though I sold at the same price I bought the first 44 shares at, I still managed to make a profit of $152.59, or 2.88%. Not a bad result in the end.

Useful as this strategy is, it’s important to remember that this is a risky move and it shouldn’t be made emotionally – if RIO had fallen further then it could have cost me much more instead. But for me, it made sense at the time because RIO seemed to be good value, and it worked out well.