Investing in the stock market is one of the best ways to build long-term wealth. If you study any financially successful person in recent times, it’s likely that they have a lot of their money in investments. But, with so much information flying around in the financial world, what strategy should you follow that will produce the best long-term results? Should you invest in market lows / a bear-market, or wait until stocks are trending upward? Should you hedge your investments or just set stop loss orders? Is there ANY trading strategy that you can reliably use?
If you’ve been involved at all with investing (or even if not), it’s likely that you’ve heard of the term “buy the dip”. This is an investing strategy where you basically wait until the stock market “dips” before putting your money into it. In recent years it’s gained a lot of popularity as both a philosophy/catchphrase, and also an actual way of investing.
So, is “buy the dip” actually as good as it’s hyped up to be? You’ll find out in this post. This post will cover exactly what “buy the dip” means, how it works, some pros and cons of buying the dip, and what you can take away from it all. Let’s dive in and find out whether buying the dip can make you any money!
What Is \\”Buy the Dip\\”
Before we get into the merits of buying the dip, it’s important to know exactly what we’re talking about here.
Generally speaking, to “buy the dip” is to buy an asset after its price has dropped or is on a downward trend, expecting a reversal of price. This is founded on the belief that the “dip” is temporary and that soon the asset (normally stock prices) will bounce back up to its original price. It’s kind of like a sort of price arbitrage.
In theory, you can “buy the dip” with any asset class including real estate, gold, and commodities. In reality, though, it’s only really executable on one kind of asset: stocks. No other type of asset gives you such accurate real-time data and allows you to make trades fast enough (can you imagine trying to figure out the price of a property every day, waiting for a drop one day, and then executing the buying process that exact day while the price is still low before the market becomes bullish again).
If an investor (or trader) successfully adds to their position on a stock, ETF or mutual fund at a lower price, they are said to be “averaging down.” This means that they’re lowering the average cost of their stock. IF, however, you buy the dip and the stock continues to go down even further, you’ve just “added to a loser”.
If you have the right strategy and enough emotional control, buying the dip can be a profitable investing strategy. That being said, it’s not guaranteed to work out well and whether you make any money completely depends on the situation.
How Does \\”Buy the Dip\\” Work?
Even though buying the dip sounds simple, there are actually many questions you need to think through before trying it out. These include:
- What consitutes a “dip”? (50% drop? 40% drop? 10%? 5%?)
- After the stock “dips,” will you pile in all your money at once or slowly invest it?
- When do you stop putting in money? (What if a stock drops from $100 to $50 and it stays at $50 for 3 years?)
- How are you going to withstand volatility and peer pressure when all the other traders are selling? (if the price dips that means that more people are selling than buying).
All of these questions need to be answered so you can formulate a plan for buying the dip. To illustrate, here’s an example of how you COULD use this “buy the dip” investment philosophy and put it into action. Rules:
- A dip is constituted by a 40% drop in the stock price from the all time high.
- After the stock dips down to that level, pile in all the money on hand that has been saved up and continue investing a set amount every month until the stock reaches it’s previous all time high price.
- Keep waiting for another 40% drop to happen.
If you followed these guidelines and chose to invest in the general stock market from 1970-1990, this is what your buying would have looked like.
AND if you had done this to the tee, you would have beaten out dollar cost averaging by a little bit from the period 1970 to 1990.
Pros and Cons of \\”Buy the Dip\\”
As with every investment strategy, it’s important to weigh the advantages and disadvantages before diving in. Of course, like mentioned above, there are different ways to execute the “buy the dip” strategy. In general though, here are the pros and cons of trying to buy the dip:
Pros of Buying the Dip
- In theory, buying the dip works – in general, you want to “buy low and sell high”. If you just do that, you’ll make money off of any investment. The “buy the dip” strategy is a strong proponent of this philosophy (it doesn’t tell you to sell as soon as the market dips but rather to buy more!)
- Could beat DCA market returns – depending on how you set up your buying the dip strategy, you could have a decent change of beating regular dollar cost averaging.
- Going against the flock – in general you should “be greedy when others are fearful and fearful when others are greedy” as Warren Buffett says. Buying the dip align with this philosophy perfectly as generally when the market dips, that’s when people are panic selling.
- You don’t need too much technical analysis to execute this strategy – you don’t need to know anything about the moving-average or investor sentiment or support and resistance to “buy the dip,” you just need to wait for a pullback above a certain threshold, and pile your money in!
Cons of Buying the Dip
- On average, DCA wins – looking at data for the past 100 years, if you compare the DCA strategy vs the “buy the dip” strategy, DCA wins in almost every scenario unless you set up your “buy the dip” strategy very specifically.
- Buying the dip is a tough emotional task to undertake – in theory, it’s easy to say that you’ll just “buy the stock when it dips,” but it can be hard when the moment actually comes. “What if the stock drops some more and I’m adding to a loser?” Executing this strategy effectively is tough to say the least.
- Your money is sitting in cash for too long – by waiting for a dip before investing your money, you risk keeping your holdings in cash for too long. Yeah you might buy in at a discount, but you also might miss out on massive gains. For example, if you tried to wait for the dip from 2000-2020, you would’ve missed out on over 100% of returns! (In other words, if it’s a bull market for a long time, buy the dip doesn’t really work)
Buying the Dip Examples
Like any other investing strategy, there are good example and bad examples for buying the dip. There are plenty of good examples out there. Take Apple (APPL) stock for example. APPL stock was trading for about $3 a share in 2009, I think we all know where that stock has ended up. Like any other stock, it’s had its dips along the way, but has clearly rising above each of them.
For all the good, there are certainly bad examples that can be disastrous when buying the dip. In extreme markets, like the 2008 market crash\financial crisis, not all stocks eventually bounce back. Two major stocks in Bear Stearns and New Century Mortgage are two examples of this. Both stocks were hit hard after the market collapse and neither recovered. Buying the dip here would mean you’d eventually lose your entire investment.
Recap of “Buy the Dip”
The stock market today is full of people trying their best to make money. Some do trend trading, others do chart analysis, and others still have no investing / trading plan at all. In all of this noise, one strategy has gained tons of popularity recently: buy the dip.
The investment strategy of “buying the dip” is unique and (in theory) can be useful if executed properly. In practice, it’s very hard to follow through on.
So you might be thinking at this point in time “what then is the point of ‘buy the dip’? If it’s not practical, when can it be useful?”
The answer is that buying the dip is an awesome guiding philosophy for when the dow jones industrial average drops, everyone is bearish, and you’re thinking of SELLING. If you’ve been consistently dollar cost averaging into a large index fund (or ETF) and all of a sudden it drops, the worst thing you can do is panic sell. You’re much more likely to miss out on lots of gains by letting short-term market movements influence your decisions than you are to “cut your losses”. By reminding yourself to “buy the dip,” you are avoiding this tragedy.
So get out there and start investing, and whenever you’re about to panic sell because of a market correction, tell yourself “buy the dip!”