In How to Trade in Stocks, Jesse Livermore wrote:
I have warned against averaging losses. That is a most common practice.
Great numbers of people will buy a stock, let us say at 50, and two or three days later if they can buy it at 47 they are seized with the urge to average down by buying another hundred shares, making a price of 48.5 on all.
Having bought at 50 and being concerned over a three-point loss on a hundred shares, what rhyme or reason is there in adding another hundred shares and having the worry double when the price hits 44?
At that point there would be a $600 loss on the first hundred shares and a $300 loss on the second hundred shares.
If one is to apply such an unsound principle, he should keep on averaging by buying two hundred shares at 44, then four hundred at 41, eight hundred at 38, sixteen hundred at 35, thirty-two hundred at 32, sixty-four hundred at 29 and so on.
How many speculators could stand such pressure?
So, at the risk of repetition and preaching, let me urge you to avoid averaging down… Why send good money after bad?
Keep that good money for another day. Risk it on something more attractive than an obviously losing deal.
In practice, Jesse Livermore would have traded with the trend, against the “suckers” who were trying to average down.
Since the stock price was falling, he would have sold it short and, as the price continued to fall, he would have pyramided his position.
Every time the market moved in his favor, he would have bought a larger number of shares than he had bought the previous time.
His gains would be identical to the losses incurred by someone who was averaging down.