What Is Buy the Dips?

“Buy the dips” refers to buying an asset when its value has dropped. The belief is that the new lower price represents a bargain because the “dip” is only a temporary blip and the asset will rebound and increase in value over time.

What Is Buy the Dips?

Understanding Buy the Dips

Investors and traders frequently hear the phrase “buy the dips” after an asset’s price has fallen in the short term. Some traders and investors believe that when the price of an asset drops from a higher level, it is a good time to buy or add to an existing position. The theory of price waves underpins the concept of buying dips. When an investor buys an asset after it has fallen in value, they are doing so at a lower price in the hopes of profiting if the market recovers.

Depending on the situation, buying the dips has a variety of contexts and different odds of working out profitably. If an asset falls within an otherwise long-term uptrend, some traders refer to this as “buying the dips.” They believe that after the drop, the uptrend will resume.

Others use the phrase when there is no secular uptrend but they believe one will develop in the future. As a result, they buy when the price drops in order to profit from a future price increase.

Averaging down is an investing strategy that involves purchasing additional shares after the price has dropped further, resulting in a lower net average price. If an investor is already long and buys on the dips, they are said to be averaging down. Dip-buying, on the other hand, is said to be adding to a loser if there is no subsequent upturn.

Limitations of Buy the Dips

Buying the dips, like any other trading strategy, does not guarantee profits. A drop in the value of an asset can occur for a variety of reasons, including changes in its underlying value. Just because something is less expensive than it was before doesn’t mean it’s a good deal.

The issue is that the average investor has little ability to tell the difference between a temporary price drop and a warning sign that prices are about to fall dramatically. While there may be unrecognized intrinsic value, increasing the percentage of an investor’s portfolio exposed to the price action of that one stock simply to lower an average cost of ownership may not be a good reason. Averaging down is viewed as a cost-effective method of wealth accumulation by proponents, but it is viewed as a recipe for disaster by opponents.

It’s possible that a stock falling from $10 to $8 is a good buying opportunity, but it’s also possible that it isn’t. There could be legitimate reasons for the stock’s decline, such as a change in earnings, bleak growth prospects, a change in management, poor economic conditions, a contract loss, and so on. It could continue to fall—all the way to zero if the situation worsens.

Managing Risk When Buying the Dip

Risk management should be a part of all trading strategies and investment methodologies. Many traders and investors will set a price for an asset after it has fallen in value in order to manage their risk. If a stock falls from $10 to $8, for example, a trader may decide to cut losses if the stock falls to $7. They are buying because they believe the stock will rise from $8, but they also want to limit their losses if they are wrong and the asset continues to fall.

Buying the dips works best with assets that are trending upward. Dips, also known as pullbacks, are a common occurrence in an uptrend. The uptrend is intact as long as the price makes higher lows (on pullbacks or dips) and higher highs on the subsequent trending move.

The price has entered a downtrend when it begins to make lower lows. As each dip is followed by lower prices, the price will continue to fall. Most traders avoid buying the dips during a downtrend because they don’t want to hold onto a losing asset. Long-term investors who see value in the low prices may be interested in buying dips in downtrends.

An Example of Buying the Dip

Consider the financial crisis of 2007-2008. Many mortgage and financial companies’ stocks plummeted during that time. Bear Stearns and New Century Mortgage were two of the hardest-hit financial institutions. An investor who follows the “buy the dips” strategy would have bought as many of these stocks as possible, assuming that prices would eventually return to pre-dip levels.

Of course, this never happened. Both companies closed their doors after their stock prices plummeted. New Century Mortgage’s stock fell to such low levels that the New York Stock Exchange (NYSE) temporarily halted trading. Investors who thought the $55-per-share stock was a bargain at $45 would have lost a lot of money when it dropped below a dollar per share a few weeks later.

Apple (AAPL) shares, on the other hand, increased from about $3 to more than $120 between 2009 and 2020. (split-adjusted).

Buying the dips during that time would have paid off handsomely for the investor.

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