Averaging down is basically where you lower the average cost of a particular share holding when the stock declines. So for example, if you bought 10000 @ 100p and the price dropped to 80p, then if you bought another 10000 @ 80p then your average price, and therefore your break-even point excluding costs, would now be 90p.

It sounds a good idea in theory, but it's generally argued that in most cases averaging down is a bad idea, simply because you are adding to a losing position.

My own view is as follows. If you are short-term trading a financial instrument and taking a position long or short, then averaging down is a very dangerous game to play.

A losing position can very quickly become a much larger losing position and with the added effects of leverage (where you can take a position up to around 200 times your trading capital) your losses can quickly get out of hand and you can even get wiped out. Indeed this is how so many seemingly profitable traders suddenly become ex-traders.

So if you're short-term trading my own view is that you should employ strict small losses and don't even think about averaging down.

If you're investing in shares for the longer term, however, then I think averaging down is a reasonable tactic to employ to a certain extent.

If you are taking a long-term view of a company, and you know that the company is growing it's profits year after year, increasing it's dividends, etc, and believe this is set to continue for the next few years, then buying on weakness can be a very profitable strategy.

Sometimes a company's price can be dragged down with the wider market and suddenly starts to look very cheap based on future earnings forecasts, so when this happens I believe averaging down is definitely worth considering.

This is exactly what happened to Tesco earlier this year. Despite growing it's profits year on year and expanding it's worldwide operations it's share price still fell from around 480p to 390p during the summer when the whole stock market fell away due to fears of a credit crunch. I actually used that opportunity to buy a few more at 396p, and thankfully it's since bounced back and as I write it's currently priced at 460p.

The only exception to this generally sound strategy is when there is a good chance that the market as a whole will collapse, in which case it's best just to sell out completely and buy in later at a reduced price because even very strong companies can get dragged down in times of market-wide weakness.

You've also got to be careful averaging down with smaller companies because less information is generally known about these companies and profit warnings can come out of nowhere sometimes. Also because they are less actively traded they can be slowly dragged down and ignored even if they are quite profitable companies.

So in general I think averaging down and buying on any weakness is a good strategy, but only when dealing with larger dividend-paying companies and taking a longer term view, as their share price should continue going upwards if they keep growing their earnings and raising their dividends.