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April 27, 2014

Don’t Average Down Your Life

by alive

 

One of my interests is watching the market. The action can be as exciting as any MMA match, with bulls and bears tussling for a grip, a stranglehold and a pin.

 

Recently, watching the NASDAQ take a tumble and many momentum stocks plunging, something was obvious: the attempts by hopeful traders to catch a falling knife with many previous high-flying darlings, and then continued buying as prices kept falling.

 

 NASDAQ

They see a stock drop really low, hope it’s about to make a turnaround and head up, and start to buy. Unfortunately it’s often a false recovery, and as prices continue falling, what do they do next? They average down.They buy more at a lower price, thinking when the stock turns around, they’ll be able to reap greater rewards from their continued investments of cash.

 

In the end, many of them end up with huge losses, sometimes unrecoverable.

 

It struck me that in Life, many of us do the same thing. We may not realize it, but anytime we accept a bad situation and pour more into it hoping things will turn around, we’re effectively averaging down our lives. In fact, many lessons from the stock market can be extrapolated to Life in general, because much of the underlying psychology driving the action is the same. Indeed, the emotions of greed, fear and hope are present in all aspects of Life, and can bring us to equally ruinous endings.

 

Today we’re going to look at two HUGE areas of Life you might be averaging down.

 

 

The Setting

First, let’s have some background concepts. We’ll see how these have parallels in our Life examples later.

 

Entry Point: This is where someone enters the stock. Let’s say you bought stock of XYZ at $100 per share. If prices drop below that, you would have to wait for it to rise until it hit $100 per share again before you are at breakeven (for sake of simplicity we’re ignoring transaction costs).

 

Potential: Investors buy a stock because they hope it will rise. Logically, they do this when the stock is trading at an attractive price and they believe there is great future potential. Less logically however, some buy a based on past performance. For example, people might buy XYZ at $100 not because they have evaluated its future potential but because its price was once $120. So they think they’re getting a bargain.

 

Catch a falling knife: When a stock takes a dive, there are always people who try to predict when it will stop falling and ‘catch’ it right before it rises again. They are trying to buy the bottom so that they can make a bigger profit on the way up.

 

But often this doesn’t work, and the stock keeps going down after buying in. Here’s an example how trying to catch a falling knife didn’t work out too well for this stock.

Falling knives

 

So what do many people do?

 

Average down: An investor buys more thinking since his average price will be lower, he will break even and profit earlier when prices rise again.

 

Here’s the reasoning.

 

Say you bought ten shares of stock XYZ for $100 each. That’s a total investment of $1000.

Then XYZ drops to $90. If you buy another ten shares for $90, you pay an additional $900.

You now own 20 shares for an average of $95.

 

 Cost Averaging 1

The idea is that since the average cost has decreased, you will break even or even make a profit sooner. The stock only needs to rise above the new lower average and you will start making money, rather than having to go above $100.

 

The problem with averaging down is, you simply have no idea when the downslide is going to end. The danger comes from betting that a bad situation will turn around, and that putting more effort into it will pay off bigger rewards later.

 

What if the share price fell to $80, $70, $60…. Would you still buy more? Sure, your average cost will continue to go down, but now your total loss is ever increasing. At which point do you stop?

 

Cost Averaging

Does averaging down ever make sense? Yes, when there is a clear uptrend. Then, buying with temporary drops (called buying the dips) is a good way of adding to your investment.

 

 

Trend: Most stock prices follow a certain direction for a period of time. They are said to be trending, and when they are generally drifting up, the trend is upwards. Ditto for the opposite. There will often be ups and downs but the general direction should be clear.

 

 Uptrend

 

Capitulation: When prices keep falling, many people finally reach a point of capitulation. This happens when the pain gets too great, and any hope of recovery is lost. The trader sells everything and cuts his (now very huge) losses.

 

Total Loss: And what happens to the remainder who keep on hoping and don’t even capitulate? They are left with NOTHING. A stock can go all the way down to zero when the company goes bankrupt. Remember Enron?

 Enron stock chart

With that background, let’s see how these ideas play out in parallel in two common Life situations – relationships and work.

 

 

Relationships

 

Entry Point: This is where someone enters a relationship, having decided to take that risk. Getting into any relationship involves risk, but without risking your heart you cannot gain all a relationship could give you. Is the guy who just approached you on the street a player, a decent and confident person who found you attractive and wanted to know you better, or an axe murderer?

 Lovers tiptoe

Potential: People enter the relationship because of the potential to be happier than they already are. There is something attractive about a person that promises reward – happiness, connection, sharing and creating a Life together.

 

But just as you should buy a stock because it is attractive to you right now, you should enter into a relationship with someone for the qualities you already find attractive.

 

Remember some people who buy in because a stock was once attractive and they hope it will recapture former price glory? Similarly many people get into a relationship with someone because of who or what they once were, not as they are now.

 

Maybe it’s someone who has negative views in Life because they’ve been hurt, but you know they were once caring, giving people. And you think your love and effort can get them back there.

 

Maybe you fall in love with a player, despite high chances of being hurt, but you buy his story that he’s this way because of the many women who have hurt him, and you think that maybe you can be that special person to save him and restore him to the decent guy he once was.

 

Big mistake. You need to love someone as they are right now, not with who you think they could be.

 

 

Averaging down: Once in a relationship, most people give it their best effort. They put their heart and soul into it. Sure, there are ups and downs. But a relationship that is working should be on an uptrend. There are little dips, like challenges, arguments, disagreements, and you should put a little more into it at this time because these  infusions of effort will strengthen your relationship long term.

 relationship downs

But if a relationship is in a downtrend, and every day is misery, unhappiness, abuse, disappointment, then putting more in will create just more and more hurt.

 

There are many people in this situation. They may be overly kind and giving. Or they may be people who have low self-esteem and don’t believe they can do better. Or they simply disagree with the idea of giving up, no matter how bad things become.

 

Continuing to believe that things will reverse any time, helped perhaps by little bounces such as declarations of faith, love and other momentary niceties, they keep on investing their energies and their emotions.

 

Capitulation: The maximum pain point represented by capitulation happens in relationships too. This is when people are confronted with a situation they cannot deceive themselves about any more. They finally realize that not only is nothing going to change, and it will only get worse.

 

For example, a guy may ignore signs of a double-timing or cheating girlfriend until forced to acknowledge it by photo- or videographic evidence, or seeing it with his own eyes. Often, after instinct and everyone else has warned him time and again that she was playing him.

 cheating girlfriend

Perhaps, a girl who has become accustomed to physical abuse from her boyfriend gets hit for the fifteenth time, and this time fractures her jaw, requiring surgery and being unable to talk and eat for weeks.

 fractured jaw

Maybe, after many promises made and broken, when the savings put aside for a child’s education has been completely lost to gambling by a husband, the wife is forced to acknowledge that things have reached a stage of no recovery, and that continuation will lead to eventual and utter tragedy.

 lost savings

 

Total Loss: And just like the few who hold a stock all the way to the bottom, those in relationships who refuse to free themselves end up living the rest of their lives in misery, unhappiness and never getting that chance to meet someone who could really make them happy.

 

 

 

Work and Career

What about work? How often have you known somebody who wasn’t happy with work? They complain about it every day, suffer every day, and yet they put in more and more effort, every day. Perhaps…YOU?

 

Entry Point: Wide-eyed, we prepare to enter the work force with great trepidation, but also with great hope. Finally, you take the plunge and decide on a job offer, after considering a few options. Like trading there’s always an element of luck. Will you be treated right, will your job give you what you hope for? But weighing the pros and cons you made a decision with one employer, hoping to further your career and progress from strength to strength.

 new job

Potential: People go for interviews, sit through grueling selection tests and are willing to work very hard because of the potential for career fulfilment and advancement. They base their decisions on research, the interview process, and also the job scope they were sold on during the selection journey. It is fair to hope that with your investment comes greater knowledge, bigger opportunities, and increasing income.

 

AGAIN… Remember some investors who buy a stock not for future potential but because of past glory? Often, the warning signs are there – a position that was once held in great esteem, but has been vacant for a very long time, with no internal transfers to fill it. Instead of seeing the obvious sign – no one wants this dog – they get sold and fixate on the selling points, such as what the ‘right person’ who is ‘up to the challenge’ could do. They fantasize that that person could be them.

 

Averaging down: Fast forward a few weeks. Once on the job, it may take months to fully learn the ropes, but it usually takes just weeks to have a very good idea about the path you’ve chosen, the office political structure, and the realities of the job itself.

 

People do try, and expect it won’t be all rosy.

 

In the workplace, you cannot avoid certain downs. Things like office politics, last minute crises, unnecessary time wasters, irresponsible colleagues, ineffectual bosses.

office politics

 

But you do want that uptrend. You want a positive balance at the end of the day.

 

You want to learn. You want to gain experience. You want to contribute. You want better working relationships. You want to be recognized.

 

And if a job gives you none of that, but actually takes more out of you than you get out of it, you will find yourself investing more and more until you reach a point you have nothing more to give.

 satisfaction gap

There are many people in this situation. They may be people who have an innate principle of loyalty to the company even after years of no return. They might be people who stay on because there are people they care about, such as subordinates they have been protecting. They may be crusaders who believe by hanging on they can make it a better place. They may be people who unfortunately believe they have no other options.

 

Again, there might be little bounces that trick people into thinking things are turning around. A boss makes a rare apology for his abusive behavior. A surprise bonus. Your manager says he sees potential in you and hinting that big things are going to come your way soon. A pep talk by the CEO who visits once and then isn’t seen

 

Capitulation: And then you hit that final straw. The maximum pain point.

 

Maybe it was being passed over for a promotion you knew you definitely deserved. Maybe it was a major project that dominated your Life for the last six months culminating in huge success… and your boss swooping in to claim all the credit. Maybe it was a promised salary bonus… if you just tahan a bit for a year… and then when it came time, it didn’t manifest.

 

Whatever it was, you finally capitulated and threw in the towel by throwing in the letter. By then, what have you lost? Sweat, tears, energy, and worst of all, opportunity cost.

 

 job burnout

 

Total Loss: The sad thing about a job is that your value as an employee also depends on your age. The longer you hold on, thinking you just need to give that little bit more before a turnaround, the older you get. And ageist as the workplace is, it’s not so easy to change jobs so easily.

 

And that’s why the tragedy is that there are thousands of people now doing jobs, holding positions and just slogging till 6pm, then going home tired and unfulfilled, where anything else is better, even eating fast food while watching TV. In the few hours they have left, they indulge in the comfort behaviours that may not be the healthiest, before going to sleep, then wake to repeat the daily cycle all over again.

 

 

 

Today we have borrowed ideas from investing to describe in parallel two unfortunate situations many people are trapped in. Because of the huge proportion of time, energy and emotion usually invested in a relationship and in a career, they contribute greatly to the quality of Life you will experience. Dissatisfaction and suffering in these areas will affect the ability to live Life as fully and happily as you might want.

 

Let’s see in a future article if parallels from investing can again be used, this time to give us a better course of action.

 

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