What is the Average Buying Price of a stock?-by Scripo

Average Buying Price of a stock is "the total amount invested in the stock" divided by "the total number of shares purchased of the stock".

$Buying Average Price = \frac{amount invested in the stock}{total number of shares purchased}$

Average Buying Price using Arithmetic mean

One way of calculating Average Buying Price is using the arithmetic mean. In a sense, Average Buying Price is the arithmetic mean of individual share's price that you have bought over time.

Example 1

Say you have bought three shares of a company at prices: $1, $2, and $3, then Average Buying Price would be:

\frac{1 + 2 + 3}{3} = 2

You can say that you paid $2 for each of the three shares.

Example 2

Say you have bought five shares: three shares for $2 and the rest for $4, then Average Buying Price would be:

\frac{2 + 2 + 2 + 4 + 4}{5} = 2.8

You have purchased five shares for $2.8 each.

Average Buying Price using Weighted Average

In practice, it is not easy to add up individual share prices. It can be simplified using a mathematical formulation called Weighted Average, which takes purchased quantity and the price (for which many shares are collected).

average price = \frac{p_{1} \times q_{1} + p_{2} \times q_{2} + ... + p_{n} \times q_{n}}{q_{1} + q_{2} + ... + q_{n}}

- p1 is the price at share unit - q1 is the number of shares bought at price p1 so on

In a grand sense, you reach back to the invested amount of a transaction by multiplying purchased units with unit price. Weighted Average helps you calculate the average price over multiple transactions.

average price = \frac{{investment}_{1} + {investment}_{2} + ... + {investment}_{n}}{q_{1} + q_{2} + ... + q_{n}}

In practice

Let's understand Weighted Average formulation with an example:
Say you have bought five shares: three shares for $2 and the rest for $4, then Buying Average Price would be:

\frac{2 (p_{1}) \times 3 (q_{1}) + 4 (p_{2}) \times 2 (q_{2})}{5} = 2.8

Significance of Average Buying Price

Average Buying Price acts as a reference for calculating your profit & loss. Selling or purchasing some shares requires calculating the new Average Price. Understanding how the new price is calculated helps in making well-informed decisions.

Let's understand it with an example:

Extending example 2, let's say you buy five additional shares for $3; you need to recalculate the average price:

\frac{2 \times 3 + 4 \times 2 + 3 \times 5}{10} = 2.9

You don't need to add the individual share price to your calculation; instead, you can use the previously calculated average price, i.e., $2.8

\frac{2.8 \times 5 + 3 \times 5}{10} = 2.9

You don't need to remember or apply the formula on your own; Scripo has created a tool for you for such calculation.

Summary

In simple understanding, Average Buying price is the total amount invested divided by the total number of shares purchased. It acts as a reference price for communication and calculating profit & loss.

In real life, you don't buy shares in a single transaction; you might need to estimate the "future buying average" before you invest more in the stock. So, understanding how average buying calculation works can save you from blunders.

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