Averaging up is the process of buying more shares of stock as the stock price goes up. It is called averaging up because the average purchase price for your portfolio position goes up.
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.
Averaging up is also a common strategy in growth stock investing. When you buy growth stocks to hold for the long term, you expect them to go up. The more the stock has good quarters, the more it validates your thesis and deserves to become a bigger position in your portfolio.
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:
Each time you bought more shares, your average purchase price per share went up. Because Roku proved to be a great growth stock, it worked out. By August 2021, the stock price was over $400 per share. In that case, it would be better to own 300 shares with an average price of $126 than just 100 at an average price of $52.
Now let’s assume you dollar-cost averaged into the position over the year 2019. Here’s what the buys would have looked like:
By the end of 2019, Roku’s stock was trading for $134 per share and your average purchase price was almost triple your original price. Even though some of the prices were lower than the month before, each monthly purchase was considered an average up because the average price for the position went up.
There is a risk with dollar-cost averaging. If your stock skyrockets, like Roku did, you’ll have far lower returns than if you had just bought it all at once.
Averaging Up vs. Averaging Down
|Averaging Up||Averaging Down|
|Buying at higher prices||Buying at lower prices|
|Trade is already profitable||Trade isn’t profitable till the stock price starts increasing again|
“Averaging down” is probably a more widely used term because it is a popular concept in value investing. When you average down, you buy more of a stock even though the stock price has fallen—the opposite of averaging up. This is also called “falling knife” investing.
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.
The obvious risk to averaging down is that you could be wrong about the trade or investment, and the price will continue to move against you.
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.
- Averaging up, or pyramiding, is when you add to a position after the price has gone up.
- Investors and traders like to average up because they view the price increase as validation of their original thesis.
- Averaging down is the opposite of averaging up; traders buy more to “average down” even though the price has gone down.
David Gardner and Tom Gardner. “The Motley Fool’s Rule Breakers and Rule Makers: The Foolish Guide to Picking Stocks.” Pages 19-20. Simon & Schuster, 2000. Accessed Jan. 27, 2022.
Roku. “Roku Prices Initial Public Offering.” Accessed Jan. 27, 2022.
Yahoo Finance. “Roku, Inc. (ROKU): Historical Data, Monthly.” Accessed Jan. 27, 2022.
Yahoo Finance. “Roku, Inc. (ROKU): Historical Data, Daily.” Accessed Jan. 27, 2022.
Roku. “Q2 2019 Shareholder Letter.” Accessed Jan. 27, 2022.
Roku. “Q2 2020 Shareholder Letter.” Accessed Jan. 27, 2022.