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Strategy of averaging
Application
STRATEGY OF AVERAGING
The average price is calculated as the balance sheet result of all cash inflows and outflows for this instrument divided by the current amount of the instrument in the portfolio.
The strategy of decreasing the average price (ideally, zeroing the average price) of an instrument serves the purpose of receiving the maximum profit from dividends as a result of obtaining the best ratio of dividends (per unit of instrument) to the average price of an instrument, as well as to ensure guaranteed break-evenness of own investments in an instrument in case of an unforeseen decrease in the real price.
The strategy is to manipulate the purchase and sale of a certain estimated amount of an instrument at the points optimal for trading, while you always have a certain target part of the instrument for which you plan to receive dividends.
If you own a certain package of instruments with dividend yield and zero average price, you will annually receive only net profit from dividends. Simply put, you will own company assets that have paid off in full and bring you passive income.
Examples of the payback period of an investment in an instrument (assuming that the dividend per share is constant for the entire period) :
Without an averaging strategy:
- The average annual dividend per share is 8% of the real price - the investment will pay back only after 12.5 years.
By strategy of averaging:
- Average annual dividend per share is 20% of the average price - the investment will pay back in 5 years + time to average.
- The average annual dividend per share is 1/3 of the average price - the investment will pay back in 3 years + time to average.
- Average annual dividend per share is equal to the average price - within a year you will receive 100% of dividend profit and thus will recoup the investment. Payback period is 1 year + time for averaging.
As you can see from the examples with the strategy, the time for averaging remains an unknown value. It depends directly on your abilities as a trader, on your knowledge of technical and fundamental analysis, and on the application of mathematical calculations, which will be discussed below.
Extremely unlikely mathematical example of averaging and ultra-fast payback period:
You have justified expectations (or have information from an insider) of a near 3-fold increase in the share price. Having marked the desired target number of shares in the amount of 100 lots, you buy a block of shares that exceeds the target number by 3 times, i.e. 300 lots. After successful forecast and price rise by 3 times, you sell 2/3 of the asset, leaving 100 target lots with an average price of 0 and fully refund your investment.
Calculation: Number of lots = 300, investment = (300 * price),
Profit = (300 * price) - (200 * (3 * price)) = - (300 * price) = - investments
Total: Number of lots = 100, with average price = 0.
Transactions on receipt of cash inflows by the instrument:
- buying operations
- buying and selling commissions
- tax charges
- other expenses (brokerage service, etc.)
Transactions on receipt of cash outflows by the instrument:
- sales operations
- dividends
- other profits
PRACTICAL WAYS OF AVERAGING
The price of the tool rises or falls as a rule in a certain channel and has a wave shape with maximum and minimum peaks.
The goal is to try, using mainly technical analysis, to buy at the peaks below and sell at the peaks above, regardless of the channel direction. You can also use different indicators to help, as an example of a simple one - the Seller and Buyer Power Indicator (RSI).
You can trade on channels of different time periods. For beginners, it is better to use channels with distinct waves of a large time period, such as a clock. In this case, the frequency of transactions for one instrument will be from a couple of times a day to once a week.
Practice shows that it is better to buy and sell in portions with several bids with a difference of, for example, 0.5 - 1% to "feel" peaks with the best price.
The average price is considered based on the target amount of the instrument and will change upwards when buying and downwards to 0 (even negative with a small balance) after the sale.
There is no need to sell the entire tool. This will certainly lead to a lower average, but there is a risk that after selling, the price will go even higher and you will worsen your average. But in principle, with full confidence, nothing prevents you from selling even more than you have securities (included in the short) for an ultra-fast decline in the average.
TARGET SHARE AVERAGING
Here you can select 3 variants, which depend on the availability of free funds for transactions.
1. No additional funds, everything is invested in the target package.
In this option, transactions are made towards the sale of part of the package (for example, up to 20%) and buy back to the target amount (100%).
2. There are certain tools with the ability to increase the package, for example, up to 150%.
In this variant, transactions are made both towards sales (say, up to 50%) to reduce the package and towards purchases to increase (say, up to 150%).
3. There are means to increase the package, for example, by 2-3 times or more.
In this option, transactions are made towards purchases (the package increases to 200-300% and more), sales restore the package to the target (100%).
In Variant1, you do not risk freezing your free funds when the price goes down, but at the same time you may miss the maximum dividends.
In Variant 3, you are guaranteed to receive all dividends and is still possible plus in case of excess, but there is a risk of freezing a large amount of free funds for a long time if the price falls.
Variant 2 is more flexible, it can have both of the above options, may be not so expressed. It is more optimal in terms of risk and profit. This option has the highest trading range and therefore more profit from the trades.
Let's look at Variant 1 as an example, as it is simpler and clearer to understand.
The chart and table on the left side shows the transactions with a percentage share for trading 80%, and on the right side 50%.
Table of buy/sell transactions 80% of shares from initial purchase
Table of buy/sell transactions 50% of shares from initial purchase
Conclusions by examples:
- If you choose a larger share (80%), even if the price falls, you can keep the average below the real one and breakeven.
- During the same period, the current profit of the full package (100 ) compared to the current price (82) is almost 2 times different (3000 and 1650).
- In the example on the left, all purchases, not counting the first one, are above the current average and therefore pull the average from the bottom to itself, but never the average will be above the point of purchase for any number of lots. In the example on the right, all purchases up to point 7 are below the current average and therefore pull the average down but never the average will reach the Buy point with any number of lots. Hence the conclusion - only a preliminary big Buy and the subsequent big Sell can lower the average below the Buy points, but it is necessarily above the current average. This requires a fairly large free amount. But, being fond of averaging, there is a risk to freeze your funds for a long time waiting for the price increase.
- It's fair to say the opposite, sales above the average decrease it, sales below the average increase it (points 6 and 8 on the right).
- The greater the difference between the average price and the points of sale or purchase, the greater the change in the average for the same number of transactions.
- Decrease in the average on the left chart has strongly pronounced average drawdowns and from 8 points the average comes close to 0 and even goes far in the negative direction with the remaining part of the package at 20%. The method of extreme averaging described below can be practiced on this mathematical pattern.
EXTREME AVERAGING STRATEGY
Alternatively, you can follow the method of gradual tool set with zero average or small value.
The goal of the strategy is a methodical periodic accumulation of an instrument with an average price of 0 or close to zero starting from the first sale. Successful purchase and sale transactions achieve a gradual increase in the number of shares with a price close to or equal to zero each time.
Method of accumulation:
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1.Buy a stock package at a good entry point (with a growth forecast) for a sufficiently large amount of shares. The ratio of the share lot price to the purchase amount the less it will be, the more you will see the process. It is desirable to have a ratio of lot price to the sum of purchase less than 0.01 (1%). The share price chart should have a periodically changing character, there should be a channel in which changes will have amplitude more than 1%.
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At a point of sale with profit you sell such number of lots with the remaining part of shares having the average price close to zero. These shares have been repaid and will generate net dividend income; and whatever the price of these shares is, you will not lose your investment.
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At the point of purchase, ideally below the last point of sale (but not necessarily if the paper is expected to grow), the maximum number of lots will be purchased for the amount (or the amount that you can afford) generated by the last sale.
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Repeat points 2 and 3 and accumulate the package you need with an average price around zero and get a net dividend.Of course, there's no such thing as just accumulation in each cycle, but the trend should be positive. With the right and confident trading, you can trade extremely quickly, but with greater risk, by this technique, get a package of shares with an average price around zero or below.The table below shows how an extreme averaging calculation would look like using the same chart and deal points.
To track the process and calculate the required number of lots in sales and purchases, you can use the application Investcalc.
Table of Buy/Sell transactions by extreme strategy
At point 10 we already have 63 lots of securities at an average price close to zero (0.92), which will not be affected by changes in the real price, and which will bring only net dividends.
Instructions on extreme strategy in the application Investcalc.
AVERAGING WITH MAINTAINING THE DESIRED AVERAGE PRICE LEVEL AGAINST THE REAL PRICE
The method is suitable for those who periodically (for example, on a monthly basis) contribute new funds to the investment and want to receive from dividends, for example, not 10% per annum but 20%.
For example, the calculation of the annual percentage will look like (for simplicity, we do not take into account tax):
(Total dividend per share per year ) / (Current share price) * 100 = 10%
In order to get 2 times more percent per annum (20%) it is necessary to reduce the price by 2 times by changing the average price.
Calculation in figures:
Average annual dividend per share = 10
Current share price =100
Profit in % p.a. is 10 / 100 * 100 = 10%
Profit in % p.a. relative to average price (50): 10 / 50 * 100 = 20%
Since this method constantly "feeds" funds to increase the package, the average price when adding will tend to increase. The task is to keep it at the calculated level based on the real price. In mind to do such calculations is inconvenient, in this will help the application Investcalc.
Below are two examples of calculating transactions to maintain the required level of the average price (half of the real price) on the already familiar chart. Only initially we will have a stock of 100 lots with an average of 47.5.
Let's draw average price lines in a descending and ascending channel. With respect to these lines, let us draw the necessary average lines as a half of the real price.
For an example of maintaining the calculated average price, you can use the methods of allocating the share of the package for trading, with the difference that the transactions will be calculated with the necessary average price.
In the first option, the share of trade will go in the direction of buying, sales will determine the average price.
Purchases in transactions will be limited to 200% (maximum 200 lots), transactions for sales will agree to take such which will give the average <= calculated on the line.
In the second option, the share of trade will go in the direction of sales to an average close to 0. Purchases in trades will be calculated to the average price <= calculated on the line
You can also use both options, and at the right moment (before the dividend cut-off) average to the desired value.
Table of trades with average price "average 1"
Table of trades with average price "average 2"