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Friday, 7 December 2007

Investor's Corner: Build Positions By Averaging Up, Not Down

Everybody loves a bargain. But when it comes to stocks, a declining price shouldn't be viewed as an opportunity to buy.

That's because a falling stock is likely to continue to drop. So if you've heard that it's smart to buy additional shares of a stock when it gets rattled, don't listen.

Averaging down, as investors call this approach, has the potential to leave you throwing good money after bad.

A better tactic is to increase a position in a stock that's rising. That's called "averaging up."

This strategy means you break your stock investment into three parts. Start with an initial purchase and make additional share purchases as the stock proves itself by advancing from its breakout.

At each point 15u add, buy smaller amounts of shares. That helps you avoid losses on your entire position if the stock suddenly goes south.

The simplest way to average up is to buy half the position you plan to take in a stock right as it breaks out past a buy point.

Then, buy a smaller amount of shares as the stock rises 2% or 3% from the buy point. Make your third and final purchase when the stock is 5% past the buy point. At each stage, you add fewer shares, which is why this method is also called pyramiding.

Another way to average up is to buy your additional shares when the stock makes bullish price and volume action.

For instance, if you bought a stock as it broke out of a base, wait until it makes a pullback to its 10-week moving average.

Of course, if you add shares to your position as the stock climbs, your average price per share will be higher. While that may go against every frugal bone in your body, it's a good strategy to follow. The consecutively higher purchase prices are evidence that your stock investment is working out.

If you add from a 10-week pullback, make sure the stock is above its buy point 18om the breakout. Otherwise, buying at a lower price would mean you'd be averaging down.

Consider Alcon (NYSE:ACL - News). It broke out of a cup-with-handle base the week ended Feb. 11, 2005.

Say you bought shares as it climbed past its 82.34 buy point 16oint 1), then sat tight as the stock continued to rise in the weeks that followed.

In April, the stock made its first pullback to its 10-week moving average. This gave you the opportunity to buy shares in late March, when it started resuming its climb after rebounding from the 10-week line (point 2) following a bullish reversal on March 21.

A third opportunity to buy shares was April 22 (point 3). Shares gapped up on huge volume.

Alcon found support at its 10-week line several more times as it made its major advance.

However, all good things eventually come to an end. And that's what happened with Alcon. The stock peaked at 148.70 in late November 2005 (point 4). On Dec. 19, 2005, it fell through its 10-week line (point 5) as its daily volume swelled to the heaviest level in nearly five months.

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