Bottom-fishing And Averaging

Close your eyes. Imagine this scene. You are in a mobile-phone simulation game and driving a jeep with your goal to reach the top of the hill. The road is bumpy, it spikes up, and then goes down. One wrong turn and the road goes downhill. You have a limited game-currency you can spend on refueling. Every time you go downhill, you spend a bit of your currency to refuel and start your way up the hill. The game is set at peak difficulty, one more ambush and you go back down.

Bottom-fishing & Averaging down: Smart game or slow disaster?

In the world of investing, few strategies spark as much debate as bottom fishing and averaging down. While these approaches can yield significant rewards if executed correctly, they can also turn into costly mistakes if misunderstood. At Xylem Investment, we understand the right valuations, price, growth phases and industry sentiments and then take a call on whether to make an investment or not. Just like the jeep-game, stock markets are an expert’s play- a first-timer would perish while the experienced will suck the money out of them no matter where the market is headed. At Xylem, we understand these 2 phenomena well and consider them to be a mixed play of emotional, psychological and financial aspects. Let's break them down.

Let’s breakdown the 2 concepts further with a classic real life fiasco:

Reliance Communications was once one of India’s largest telecom players and darling of multiple investors. Founded in 2002 as part of the Reliance Group under Anil Ambani, the company quickly gained traction by offering affordable mobile services at a time when India’s telecom boom was just beginning.

However, a mix of aggressive debt-fueled expansion, failed deals, spectrum liabilities, and intense competition from new entrants, vaporised each and every investor’s gain.

Let us understand how an investor’s capital would have been endlessly eroded in RCOM:

1. Mr. A has a capital of Rs. 1,00,000. In 2006, he was aware that RCOM existed, but he held back at 250 levels. He waits for the stock to rally to get a confirmation that it actually holds potential.

2. In 2007- end, he saw the price hover around 800 levels. He gets an instant fear of missing out and then invests. He experiences quick gains as the stock gradually peaks out at 845.

3. The price came down sharply and eventually bottomed out at 135 levels. Mr. A would have gotten a chance every few days as the stock made new lows. In anticipation of another rally, he averages RCOM. The 2009 rally towards 350 levels re-ignites the hope.

4. The classic dip continues. RCOM is dragged all the way down to 45 levels. By now 90% of his initial wealth and whatever was invested later is eroded. He finally realizes. But now it is too late.

Sadly, most retail investors lose big money in the averaging down game. Stop-loss is a taboo concept, because our brains are hammered to not sell at a loss ever. We mindlessly tend to hope that eventually the share price will rise. 99% of the time it does not.

This brings us to our ‘Risk-First’ approach at Xylem Investments. Averaging down and bottom-fishing are a boon, if used well. We would not endlessly deploy capital just because a once bought share is now at a lower price. Once the lower-end targets are hit, we safely exit because we believe in capital protection, not erosion. However, there are opportunities where in a very well researched company tends to correct post buying, typically a sentimental correction, not because the company’s quality has deteriorated is a green signal to average the price down.

Risks in Bottom-fishing and averaging out:

At Xylem Investments we unequivocally stand by behavioral finance concepts. One such is the Sunk-Cost Fallacy. You tend to stick longer to things where you have invested your time and efforts already. A movie ticket where you have spent a few hundred bucks makes you sit for the whole film even when it is terrible, even post the interval because your brain is hardwired to not quit where you have spent time,money or effort already. The time, money and effort lost are referred to as Sunk-Cost and lead to obsessive behaviour and stickiness towards things which are apparently unfavourable. This amplifies the following 3 risks:

1. Catching a falling knife: A stock which has declined too fast too soon might dip further if the reasons are permanent. The falling knife if caught will leave a hole in our hands.

2. Value Trap: A declined stock may seem cheap now. There is a chance it does not deserve even the new cheaper valuation because of major negative triggers like management issues, loss of edge and industry slowdown.

3. Capital blockage: Capital is scarce. There will come a point where averaging will lead to major allocations to a bad investment.

A second major behavioural fallacy is Loss-Aversion. Well, there are 2 sides to the coin. It works wonderfully when you set a strict stop loss and avoid bigger losses in that sense. It works against you when your brain tricks you into “ I cannot face this loss, I will wait for it to turn green”. Losses of the same magnitude pinch you much more than gains could ever make you happy. This draws you into holding for a few more days. Days turn into weeks, and you are stuck with a lifelong dead investment as the losses gradually expand.

Aim for quality, not the price

A number of stocks in the market even after falling largely, fell further and never rose. Those at their All Time High, formed newer highs and consistently compounded wealth. These are a few examples, where you would have sensed the fall as an entry-scheme, but the internal weakness made the shares plunge deeper.

Stock	High	Fall 1	Fall 2
Reliance Power	375	73%	98%
Vodafone Idea	123	66%	83%
Spice Jet	157	61%	58%
Yes Bank	404	60%	93%
MTNL	229	72%	88%

Final Note

The Xylem Investments research team believes that smart investing lies at the intersection of strategy, psychology, and discipline. Techniques like bottom fishing and averaging down are not always flawed and can be powerful when rooted in research and executed with precision. We don't blindly average down to feel better about losses.

We do it when:

1. The fundamentals are intact,

2. The valuation is compelling,

3. The investment strategy justifies the move.

What separates success from regret is behavioral discipline. At Xylem, we don’t let emotions cloud portfolio decisions.

Because whether you're navigating volatile markets or timing your entries, successful investing is not about ego.

It’s about knowing the game, playing it right and making it to the hilltop.

If you'd like to discuss your portfolio or explore how Xylem can help you navigate this market, consult with us here.