Trading Strategy 1 of 5: Price Cost Averaging

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Dive straight into the first of several investing and trading strategies. I will be concentrating on investing strategies, such as Price Cost Averaging & Value Cost Averaging, where we are invested for several months to years; in future editions I will be sharing trading strategies where we are ‘invested’ for days to months.

The Price Cost Averaging or PCA Strategy laid out in this month’s article takes a small amount of time to setup and then can be completely automated with your broker. Each strategy that follows will take a little more time, but will result in a significantly better return on investment.

The most important element to today’s strategy is that it gets you started.

No stocks mentioned in these reports are recommended. For simplicity, we assume that you will invest £100 per month. This is an example only. It could be £1000 or £10,000. There are fixed charges to pay each time you trade. At time of writing some brokers charge only £1.50 for monthly trade as long as it is the same amount of money and same stock. Only invest with the amount of money you are comfortable with – but please do get started.

Also please note, that this is not a recommendation service, these articles reveal some of the various investing strategies available.

Strategy: Price Cost Averaging

The simplest investment strategy in the world has got to be ‘Price Cost Averaging’. This is how many people invest indirectly in the stock market in their pensions for example – whether you realise it or not.

How does it work?

Every month, normally at the same day of the month, a portion of your monthly income is funnelled into your pension fund. The fund manager then invests that money by buying stocks. They are not timing the market i.e. trying to get in at a low point or price; they are just buying at the current market price irrespective of whether it has risen or fallen. They don’t have to think about it. Once a month they just buy.

You might be thinking that this is so simple that you could do the same yourself, buying shares every month, saving the charges incurred by your fund manager.

You would be right!

After all, there is no thinking involved here at all – is it really necessary to pay a ‘fund manager’ a yearly management fee of 3-5% to do that for you?

This strategy takes the absolute least amount of effort. You can setup a direct debit and shares are purchased every month at market rate. With the right broker, this strategy can be set up in advance and fully automated.

Take a look at the charts below – every month the broker receives your money – £100 per month as an example. As soon as they receive it, they invest it in a stock. In January the broker invests your £100, in February £100, in March £100 and so on every month, irrespective of the price of the share.

The price fluctuates, going up and down. Every single month your broker will buy stocks at whatever the price happens to be on that date. The broker is investing the same £100 each month, but the number of shares that they buy will differ each time.

Sometimes the broker will buy when the price happens to be high, sometimes when it is low and sometimes around the middle – wherever the price happens to be. Therefore over time, you will have an average price that you ought into, hence the term, Price Cost Averaging.

Price Cost Averaging is better than investing all your money at once!

Why?

The stock below is moving up and down in price. Note that in May, June and July; the price was high at around the $31.25 mark. What if you had invested ALL YOUR money at $31.25 – your average price would now be $31.25 and for the rest of the year you would be in a loss situation.

So instead of buying once and risk buying at the wrong time, we invest the same amount of money every month to get an average price.
Price Cost Averaging Strategy Example
As you can see in the chart above, some months you would have bought low, some months high and some months in the middle.

By buying monthly, you get an average of all these prices. Since you are investing the same amount of money, i.e. £100 per month, you get more shares when the price is low and fewer shares when the price is high.

To calculate the average price you paid, add up the money you invested over the year: 12 x £100, and divide by the total number of shares that you received. That is your average price.

Without a doubt, having an average price, i.e. somewhere in the middle, reduces your risk of buying at the wrong time in the market, i.e. the high of $31.25 or even higher.

Price Cost Averaging is widely used because it takes no thought at all and can be fully automated.

This is its greatest strength because it means that most people can do it. Yet it is also its greatest weakness, because it is so random. It depends on when the money hits the brokers account.

So for example, if you decide that you are going to invest £100 at the end of each month, the broker invests the money as soon as they get it, towards the end of the month. The broker is happy to invest even, if it is right at the top because ‘the money came in’.

If however, you sent the money in the middle of the month, then the broker would have invested in the middle of the month. Can you see that you would have bought the stocks at different prices, depending on when you sent the money over?

With Price Cost Averaging we are likely to achieve an average of < 5%, depending on the stock, not bad if you are thinking of investing for your young children. Although automatable, most people don’t mind spending a little more time in exchange for more percentage returns. With my next strategy, Value Cost Averaging (VCA), which takes just 10 minutes per month, we are aiming for <15% a year. It builds on Price Cost Averaging and takes it to the next level. VCA is definitely a strategy that I would encourage you to start with in an ISA or SIPP. Watch out for my next strategy in next month’s article - Value Cost Averaging. It has been my pleasure to help you become a better trader and investor. I highly recommend you download my book now, where you can find all the long term stock investing strategies you need as well as hints, tips and tricks on how to be a successful investor and/or trader. Just click here to download now!

To your success,

Marcus