You’ll often hear Jim Cramer say that we don’t want to violate our cost basis when adding to one of our Club positions. What does that mean exactly? Here’s a closer look at our cost-basis rule, why we hold it in such high regard, and a couple of exceptions. First, a pair of investing terms. A “lot” is the number of shares and the purchase price for any trade. Future buys generate new lots. The “weighted average cost basis” (or cost basis, for short) is calculated by multiplying the average share price of each lot by the percentage of the total position size which that lot represents and adding them all up. When Jim says that our discipline forbids us from “violating our cost basis,” he means we want every new buy in a stock we own to be below the weighted average cost basis. If we’re abiding by this rule, that also means that every new purchase as we build a position is made at a price point lower than the previous purchase. As a result, each new buy should serve to reduce the overall weighted average cost basis of the position. For example, if our first purchase of a stock was made at $100 per share, we strive to make subsequent buys at some levels below that — say at $95, then at $90 and so on. Assuming we purchased 50 shares to start and 25 shares in each subsequent purchase, our cost basis in this instance would move from $100 (50/50 or 100% of shares at $100) to $98.33 (50/75 shares or 67.67% at 100 and 25/75 or 33.33% of shares at $95). A third stock purchase of 25 shares at $90 would take the cost basis to $96.25 (50/100 or 50% of shares at $100, 25/100 or 25% of shares at $95, and 25/100 or 25% of shares at $90). Most brokerage tools calculate this for you, usually in the “cost” column or “cost basis” column in the dashboard. If nothing has changed our view of the company’s fair value, every new purchase should increase our potential upside by reducing our cost basis. If our target for what we think a stock is worth is $120 per share, we had 20% upside…
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