I’ve never been good at timing the market bottom. In fact, it’s common for a stock of a wonderful business to keep falling after I’ve bought in.
But I don’t lose sleep over it. As long as I know that there’s a good probability that my purchase price will deliver me satisfactory returns in the long run, I’m at ease with not having bought at the lowest price.
In fact, my biggest nightmare isn’t paying a little more—it’s missing out entirely because I was waiting for the perfect entry point, only to watch the stock run away without me.
When a stock drops but the fundamentals remain unchanged, it often presents a great opportunity to add to your position. After all, you’re essentially getting a good business at a discount.
However, like anything else in life, doubling down can become risky when done excessively. Here are six situations when doubling down isn’t the answer:
1. You’ve Already Established a Full Position
If you’ve set a 10% allocation for a stock, stick to it. Going beyond your predetermined limit could expose you to undue risk. Before you take the leap, ask yourself: Is this really a no-brainer opportunity, or are my animal instincts taking over? Always remember: risk is what’s left when you think you’ve thought of everything. Respect it.
2. You Get Defensive When Others Disagree With Your Thesis
If you find yourself becoming hostile or dismissive toward anyone challenging your viewpoint, take it as a red flag. Emotional attachment to a stock can cloud rational judgment. Be open to opposing perspectives—they might save you from making costly mistakes.
3. Your Main Reason for Buying More Is That Respected Investors Are Doing It
It’s tempting to follow the lead of well-known investors, but relying solely on their actions isn’t a sound strategy. Their risk tolerances, timelines, or access to information may differ from yours. Always do your own due diligence.
4. You’re Trying to Lower Your Average Cost Basis to “Make It Easier” to Break Even
Doubling down just to reduce your cost basis can be a dangerous trap. A lower average price may give the illusion of reducing your losses, but it doesn’t change the company’s fundamentals or improve its outlook.
5. You Keep Changing Your Thesis to Justify Holding On
If you find yourself constantly revising your thesis to explain poor results, it’s a sign you may be rationalizing a bad investment. Making excuses for management’s repeated failures or poor execution can trap you in a losing position.
6. The Company Is a ‘Melting Ice Cube’
What looks like a temporary setback might be a sign of a deeper structural decline. Don’t assume a plummeting stock price makes it a bargain. Time isn’t kind to a business that’s slowly eroding. Be wary of companies in long-term decline.
One more tip: Before investing, conduct a “pre-mortem.” Imagine your investment goes south—what could be the reasons for its failure? What signs would signal that your thesis has broken? Thinking about the downside while you’re still rational will help you identify potential pitfalls. Once you’ve committed to a position, cognitive biases can cloud your judgment.
In my next article, I’ll dive deeper into why these mental biases take over after we’ve invested in a stock. If you’d like to follow along, make sure to subscribe to my free newsletter here: https://steadycompounding.com/subscribe/
Compound steadily,
Thomas
P.S. If you have friends who treat doubling down as a badge of honor, do them a favor and send them this article: steadycompounding.com/investing/doubling-down