Why Doubling Down Can Be Profitable

Doubling down should not always be seen as a risky bet. For disciplined investors, it is both a strategy to gain a good average entry price, as well as a form of capital preservation. The manner in which an investment decision is made can define the risk, as opposed to uniquely considering the risks prevalent within an investment. 

Takeaways

• Doubling down safely

• Why it succeeds

• How you can use it

Why is doubling down is seen in negative terms?

Doubling down is seen as a last throw of the dice. Someone who has lost money, tries to regain it by increasing their position in the hope of recovering their losses. Sadly such emotionally driven decision-making is rarely profitable. Nick Leeson famously bankrupted Barings bank by doubling down on loss making derivative positions. His creative accounting was eventually found out by a systematic risk event.

His is an excellent example where doubling down did not work and would not work. He was chasing his losses rather than closing out his position, analysing what he had done wrong and learning from it.

Why you can succeed from doubling down

Investors in publicly quoted companies face a perennial problem of when to buy. Ideally you want to buy at the bottom, but when is this? Some investors use moving averages but they are not a perfect science, and although useful are subject to interpretation.

Investing is an art, not a science.

For investors who have the time and desire to research the financial statements of a company, it is possible to work out an approximate fair value for a share. This involves working out the discounted cash flows.

Although it sounds complicated and involves some mathematics, it is the most reliable way of working out when to buy a share, as you can work out when the share has not priced in future growth. This fundamental research is time consuming and may not work for all.

A solution to lack of time

For those who do not have the time for the above, but want to take an interest in investing for themselves, there is another way. This involves pound cost averaging. A simple process which involves building a position in a stock over time. Rather than committing all your capital at once, you buy at different prices.

Ideally you will buy when the share has suffered from volatility or short-term disappointment. I.e. investors have over-reacted to a piece of news which is not as bad as they believe. You will be amazed how badly informed investors are about the companies in their stock portfolio, so you often have occasions to buy in at a discount when others have reacted without thought.

How you can use it to reduce your risk

Pound cost averaging provides a form of capital preservation by encouraging a margin of safety. If you place all your identified capital on one day and at one time, you risk getting your timing wrong. If you buy in a regular intervals, preferably at a 10% price differential from your previous trade, it is likely your average price will be close to the bottom.

You will then be in position to benefit from any move upwards. Doubling down, or even tripling/quadrupling down through pound cost averaging can also contribute positively to your emotional approach. Although we recommend watching a share price before buying in, so as to gain an understanding of how it reacts to news flow, many do not.

There is nothing which focuses the mind more than when you've put your money where your mouth is. Buying a small initial position, maybe one sixth of what you intend to commit, will often lead you to focus more than just 'monitoring' a share. This also means that if you feel you have got it wrong, you can sell out with only a small loss (or potential gain!).

Conclusion

Doubling down used in the right manner can mean profiting from an investment or even increasing the profit. It should used in a thought out manner and not as an emotional response. If things are going against you, which they easily can for those spread betting or futures trading, stop and walk away. You can then fight (invest) another day. Fundamentally you are a risk manager first and in investor second.