Thursday, June 16, 2011

Thoughts on dollar cost averaging

There's a lot of talk about using the standard chartered bank trading platform to do averaging down. The reason is because the platform offers a very cheap way to buy small lots without the penalizing minimum trading fees, which is usually $25 ++ minimum. What's averaging down actually? It's just a way to reduce the emotional part of investing by buying at suitable time interval using a fixed cost, regardless of the price. By doing that (you can do the math), when the prices are low, you'll end up with more shares and when the prices are high, you'll get lesser. Averaging out, you'll get a lower price, which is the whole point of doing dollar cost averaging.



I assume that those who are doing dollar cost averaging are those that do not have an interest in the market, hence buying a blue chip counter (generally, these people will get index instead of individual counter because index cannot go bust but a million other things can happen to individual counters, no matter what the colour of the chips are) will be safer for the longer run. I also assume that people who does dollar cost averaging do not believe in timing the market, just time in the market. The reason is that if you can time the market, it'll be better to just buy at the right time instead of whacking the counter every suitable interval.



Hence, it puzzles me that in the cbox, there are people who wanted to do dollar cost averaging using the cheap transaction cost offered by scb trading platform, but keeps looking at the market for the latest quote. The point of doing dollar cost averaging is to reduce the emotional part of investing, and also the labor of active investing, by buying at a fixed interval using a fixed cost. If I'm doing that, I'll just be looking at the market once every quarter or so, put in my transaction and carry on living my good life without the market interfering my peaceful existence.



But I'm not doing that, not in the traditional sense of averaging, no. I'm doing a TA-based averaging.



The idea is simple. You buy only when the charts show you that it is okay to buy. If the signal don't work out, I don't cut loss. I'll wait for the next point where the charts say it's okay to get and buy in another bullet. Each counter has a limit of say 2-3 bullets, and the amount for each counter and each bullet follows strict money management rules. For instance, I won't be averaging down non-stop and getting all my money stuck up in a single counter. Oh, and I only do this for fundamentally sound counters too. Averaging down on ass shares is a lesson I hope I will never have to re-learn again. Conversely, I'll do the same when selling. When I see a short signal on the chart, I'll sell a portion.

9 comments :

Temperament said...

Hi LP,"
LP:-
"Oh, and I only do this for fundamentally sound counters too."

I have been using dollar average down strategy for what you written above, since i started investing.

But after reading "INVESTOR’S GUIDE-(Richard Koch). about average up instead of down, i think his method is "beter & safer".
CW8888 has been using it sucessfully.

i will try the "new" average up strategy. At least, it looks like i can escape the proverbial "catching a falling" if i use the average up technique instead of the average down.
Maybe we should consult CW8888 for more detail of his experiences of averaging up.
What do you think?

Singapore Man Of Leisure said...

Timely post!

Dollar cost averaging is effectively saying I have no clue - close my eye and buy on a regular basis. Don't get me wrong, it's a good strategy for long term buy and hold for counters that are "fundamentally sound" (but what the hell is that!? BP? AIG?)

For those who swear by TA or FA, how can you reconcile Dollar cost averaging into your "method"?

I think most people are like me -using "rojak" (mix and match) method. Nothing wrong leh! Just as long make money, can!

Createwealth8888 said...

Similar to GPS guided driving, when GPS signals Right Turn, he turns Right.

When GPS signals Left Turn he ignores and drives straight ahead.

This is how he drives. LOL

Fergus said...

Good post on dollar cost averaging. I actually agree with your method more, but it does require a little bit of skill on technical analysis, since beginners might buy at a 'support' when it is actually not a support.

I'm quite against dollar cost averaging actually and that I think it is a jargon coined up by financial planners and all to get recurring business. Not that it is bad though.

I used to put 20% of my income into my 'untouchable' savings acct and 30% into my 'investment' savings acct. So whenever I have say $4-8k in my investment savings acct, I would be ready to buy investments, but the 'untouchable' acct is not meant to be used for anything. Recently, I was just discussing with my friends and I was just wondering if we should just invest once every 2-3 years instead? Like keep everything in a low interest savings acct for 4-5 years, resist the urge to put the money to work in an investment. Then when a market crash comes, you dump the money in the market (fundamental stocks of course), and wait for another 3-4 years.

An example I discussed with my friends is starhub.. The market low was $1.80, and the dividend yield then was 14-15%. So lets assume you didn't get the market low, but got an average of say $2.00(which was around this price for the longest of time). At this point, your dividend yield would be fantastic and your capital appreciation is pretty decent too! The only problem is brokers would hate me.. Haha (and I'm a broker)

Another example, (on hindsight, just looking at UOB's historical chart), is lets say when the market downfall came, you might have bought your first tranche at $12.50 first rebound, then again around $12.50 (supported 2-3 times), then maybe another at $11, and finally another at $9. The low was $8.20, and your average price (assuming equal tranches) is around $11.25. You might have averaged up also at $11 (support region) and maybe 1 more time at $12.50 when it rebounded like mad.. So average is still around 11.25. In any case, your 2 year return is approximately 68%. Not many 'active' intermediate investors can achieve that.. Probably only those that read the financials of many companies, attend agms, briefing and all that would fare better.

Of course, the key is to stick to the blue chip, which lowers your risk of it going bankrupt, and to have sufficient capital for 4-6 rounds of averaging) haha

Temperament said...

Hi,
Averaging down on a blue chip during a bear market can work. But like CW8888 said "Pyramid UP" is really safer and better. i want to give a try. The only problem when to start to built your pyramid? i think everyone will start at different point.

la papillion said...

Hi temperament,

U too? haha :)

I think his method is more like averaging in, instead of averaging down. Not sure what is meant by pyramid, though I've seen it in his blog before. Perhaps he can share it with us more?

Hi SMOL,

Haha, indeed, what is meant by fundamentally sound counter these days! However, one by two black swans occurrence doesn't belittle the fact that most of the time, fundamentally unsound counters crash more than the sounder ones :)

True indeed, if you can earn money consistently, you are right :)

Hi bro8888,

Haha, I totally get what you mean. You've a knack for explaining complex things in simple ways :)

la papillion said...

Hi Fergus,

Thanks for the long and well thought out comments!

Actually I had a mind to do what you proposed too, that is to invest in big amount during the crisis period. It's called crisis investing. Perhaps I would really do that, and leave a % into dividend or income stocks while waiting for that moment to come. The thing is that we might not know when it might happen...who knows if it'll take 10 yrs to come or not..haha :)

la papillion said...

Hi Temperament,

I think bro8888 had just obliged us with his new article:

http://createwealth8888.blogspot.com/2011/06/average-down-or-pyramid-up-2.html

Temperament said...

Hi,
Thank you all very much.
Cheers!