What if everything your financial advisor told you about building positions was backwards?
Walk into any brokerage office today, and you'll hear the same tired advice echoed from cubicle to cubicle: "Buy more when the stock goes down—you're getting it at a discount!" This conventional wisdom of "averaging down" has become so entrenched in investment culture that questioning it feels almost heretical.
But here's the uncomfortable truth: this approach is precisely backwards. And two legendary investors—Jesse Livermore and Nicolas Darvas—proved it over a century ago.
The Harvard Business School Revelation
In 1960, a young William O'Neil sat in Harvard Business School's library, hungry for investment wisdom that actually worked. Among the dusty business texts, he discovered Jesse Livermore's "How to Trade in Stocks"—a book that would revolutionize his thinking about position sizing.
Livermore's core insight was deceptively simple yet profound: "Your objective in the market was not to be right, but to make big money when you were right."
This wasn't about ego or batting average. It was about mathematical reality. When you're right about a stock's direction, adding to your position as it moves in your favor amplifies your gains exponentially. When you're wrong, cutting losses quickly protects your capital for the next opportunity.
O'Neil immediately adopted what Livermore called "pyramiding"—adding smaller amounts to winning positions as they advanced 2-3% from the initial purchase. This technique allowed him to concentrate his buying power when he was demonstrably correct, rather than throwing good money after bad positions.
The Averaging Down Trap
Before we dive into why averaging up works, let's examine why averaging down fails so spectacularly.
Picture this scenario: You buy 100 shares of XYZ Corp at $50. The stock drops to $45, so you buy another 100 shares, lowering your average cost to $47.50. When it hits $40, you double down again, bringing your average to $43.75. You feel clever—you've "bought the dip" and improved your cost basis.
But here's what you've actually done: You've tripled your exposure to a demonstrably failing investment. You've allocated 75% of your capital to a stock that's down 20% and showing clear signs of weakness. If the stock continues falling—which failing stocks often do—your losses compound dramatically.
This is the equivalent of a retailer seeing yellow dresses collecting dust on the rack and ordering three times as many. No successful business operates this way. So why do intelligent investors?
Enter Nicolas Darvas: The Dancing Millionaire
While O'Neil was studying at Harvard, a Hungarian dancer named Nicolas Darvas was unknowingly conducting the greatest real-world experiment in position sizing ever documented. Between 1957 and 1959, Darvas turned $25,000 into over $2 million while touring the world as a professional dancer.