There's a peculiar phenomenon in the market: while some people are celebrated as paragons of value investing for adding to their positions during a downturn, others are ridiculed as fools catching falling knives.

Open any investment forum, and the debate about averaging down is always heated. Critics are vocal, claiming it’s one of the deadliest bad habits for retail traders; while others quietly accumulate wealth with every dividend reinvestment, smiling at such critiques.

The interesting thing about this phenomenon is that both sides of the contradiction seem to have enough cases to support their stance. Those who kept averaging down during the pullback on growth stocks, ultimately losing it all, are indeed validating the iron rule of 'never averaging down on losses' with their own tragedies. Meanwhile, the seasoned investors who have consistently bought into the big four banks or the three major oil companies over the past few years have certainly reaped their share of steady gains through dividends and slow price appreciation.

Where does the problem lie? Is the act of averaging down inherently flawed?

The answer isn’t complex. Averaging down is criticized as 'catching a falling knife' precisely because of the severe issues in its application context.

In the trading scenarios of most retail investors, they aren't buying established blue-chip stocks supported by monopolistic positions and stable cash flows. Instead, they habitually average down on concepts driven by news or stocks they believe can’t fall further, grabbing at half-baked stories based on candlestick charts.

In such fragile assets, where logic can collapse at any moment, every drop might not be a mere pullback but the start of value destruction. Buying the dip here is akin to struggling in quicksand; every effort just pulls you deeper.

Jesse Livermore, revered as a spiritual mentor by countless traders, warned in 'Reminiscences of a Stock Operator' about this. He wrote: 'Among all the mistakes in speculation, few are as serious as trying to average down on a losing position.'

He also repeatedly emphasized: 'If your first trade results in a loss, making a second trade is foolish. Never average down on a loss. Etch this phrase into your mind.'

Livermore's logic is based on a clear and ruthless foundation—he engages in trend trading and short-term speculation, aiming for maximum capital efficiency.

For short-term traders, the time cost of capital is incredibly high. If the stock price doesn’t rise as expected after buying, it indicates a misjudgment. If the stock continues to drop, it's a clear signal from the market voting with real money that your previous judgment was wrong.

In such cases, using new funds to double down on a judgment already dismissed by the market is like throwing stop-loss discipline out the window, openly challenging market trends. In this system, averaging down is wrong precisely because it is counteracting the trend rather than aligning with it.

However, when we shift our focus from the speculative battlegrounds of Livermore to those slow yet steady value investors, the narrative changes drastically.

In the world of dividend stocks, investors earn not from price fluctuations but from the profits generated by the company's ongoing operations and the quietly compounding effects of reinvested dividends.

For these kinds of stocks, as long as the company's competitive moat hasn't narrowed, profitability hasn't declined, and dividend policies haven't shifted, a price drop doesn’t indicate asset degradation. On the contrary, the same dividend amount can buy more equity when prices are lower.

Averaging down at this stage is less about trading stocks and more like a ritual of asset accumulation akin to dollar-cost averaging. Whether it’s right or wrong doesn’t depend on whether the stock price goes up or down afterward, but on whether you genuinely have the patience to hold for three, five, or even longer.

If you have stable cash flow to cover daily living expenses and genuinely view buying these stocks as acquiring a property that can generate rent, then averaging down during a downturn is not just correct; it’s the most standard and rational action within this investment logic.

But the problem lies exactly here. The majority of retail investors averaging down during a decline don't possess the calm mindset or deep understanding and trust in the asset.

Even if they hold good quality dividend stocks, once the stock price drops over twenty or even thirty percent, the pressure of unrealized losses can overwhelm any rational analysis. They start to feel anxious, question themselves, and inquire if there’s some negative news brewing that they aren’t aware of.

The end result often is that they cut their positions at the bottom when they should have held on, or they sell at the first hint of a rebound, calling it a 'quick recovery.'

Thus, averaging down is often criticized as a flawed strategy, hiding a deeper human factor—it’s frequently packaged by greed in a seemingly rational way.

For many, the moment they hit the average down button isn’t a calm evaluation of asset value; it’s an urgent impulse: 'Buy quickly, or I’ll miss out on this cheap price, and if I don’t jump on this wealth train, it’ll leave without me.'

This impatient mindset leaves no room to observe whether the stock price has shown stabilizing signs and completely ignores the principles of right-side trading concerning safety margins. Fundamentally, if the driving force behind averaging down is panic over missing out rather than a rational judgment based on value, the action is already on shaky ground.

At this point, we might draw a more universally applicable conclusion.

The only true measure of whether averaging down is right or wrong is not the numbers behind your account turning red or green later but whether this action is firmly embedded within a logically coherent investment system.

If you are following a complete value investing philosophy and hold assets with robust monopolistic dividends, a price drop is merely a cheap gift from Mr. Market during his low moods.

However, if you see yourself as a swing trader, then a downturn is a loud alarm bell. Averaging down in this situation is akin to stepping on the gas in the wrong direction, compounding mistakes.

The most brutal yet fair aspect of the capital market is that it ultimately rewards those who act consistently and punishes those who waver.

In reality, we have seen too many investors like this: they comfort themselves in a downturn by saying 'I'm a value investor; I buy more as it drops,' using this rationale to numb the pain and anxiety caused by losses. When the stock finally rebounds a bit, they switch to being short-sighted traders, fearing their meager profits might vanish and wanting to cash out immediately.

Ultimately, most people lack the astounding patience required for value investing through cycles and the cold-blooded discipline for stop-losses demanded by swing trading.

They are driven by a single obsession: during the agony of a falling stock price, they want to do something quickly to cover that annoying unrealized loss. This may be the fundamental reason why averaging down is so widely criticized.

The market never rewards frequent actions; it only accurately rewards those who are honest with themselves.

Note: The market has risks; investing requires caution. Under no circumstances does the information or opinions expressed in this subscription account constitute investment advice for anyone.