In last Friday's article of
6 Tips for Timing Your Investments
, I discussed a few considerations to help you decide when to enter
and exit stock positions. Let's continue with the timing aspect of
Timing is rarely perfect, even when you know the signs to look
for and you think there will never be a better moment to buy
shares. So if trying to achieve perfection is a fool's game, I say
why bother? Better to realize perfection is near impossible, and
simply strive for an average share cost basis that is close to
With this mentality, you can control your overall cost of buying
stock by using averaging techniques.
***Dollar cost averaging is a technique in which the same dollar
amount is invested in one company at regular intervals-monthly, for
example. An analysis of the effect of this technique is that the
average price is higher than the current price in a falling market,
but it is always lower than the current price if the stock price is
For example, say you buy $1,000 of stock in six consecutive
months. During that time, the price trends downward:
Note that dollar cost averaging in this example creates an
average purchase price (the fourth column) per share that is always
higher than the current market value. At the end of six months, if
you were to sell all your shares, you would have a much smaller
loss than if you had purchased all of your shares at the initial
price of $14.15.
Dollar cost averaging when the stock's price is moving upward
creates the opposite effect - and naturally this is what we want.
Your average price is always lower than the current market value.
For example, given the same facts as above but in a rising
In this scenario your average cost per share is $14.62 after six
months. Your average price is higher than it would have been if you
had purchased all shares in the first month, but the system is
designed to protect against price decline.
But what is not shown in these tables are the actual returns for
each stock purchase. In the second scenario, you would have capital
gains over each period, so you would be sitting on an overall
positive return - without the risk of buying all shares at
More often than not, a stock doesn't move steadily upward or
downward. So dollar cost averaging can help to smooth returns and
allow you to take advantage of weakness to accumulate shares at a
***A similar technique is called value cost averaging. In this
variation, the dollar value of monthly share purchase is adjusted
based on how the stock performs. When the price declines, you buy
more shares, and when the price increases you buy fewer. This
creates the overall effect of an average basis below current share
price. It also improves your average rate of return when the price
does increase well above your average cost basis.
When using averaging techniques for buying stocks you can worry
less about timing and more about growing profits over the
long-term. Timing is an important issue because naturally you want
to buy low and sell high. But if you are looking to the long-term
and plan to hold your small cap stocks as both growth and value
portions of your portfolio, short-term timing is not as crucial an
issue as the more critical stock selection itself.
***You have a lot to think about as an independent investor. You
have to master an array of different kinds of orders and decide
which work best for you; identify the threats and determine your
own risk tolerance. Most of all, you have to time your buy and sell
decisions to make the best use of capital, avoid loss, and maximize
your profits. All of these challenges rely on experience - and
selecting the best sources for information for research.
The Small-Cap Investor: Secrets to Winning Big with Small-Cap
, is filled with every tip and trick I know about investing in
small-caps, and I think it's absolutely vital to anyone interested
in the topic. There is a ton of great information in the book, and
it is a great compliment to
Small Cap Investor PRO
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