Is it Wise to Buy on Dips?

If you liked it at $0.58, you should love it at $0.50, right? Whether it’s an asset priced at $60,000 or valued under a dollar, the “should I buy the dip?” question is the same. The answer may depend on what kind of investor you are and if it is consistent with your style. 

Buying the Dip

Pullback buying is an investment concept best suited for patient investors with faith in cycles, some “dry powder” with which to scale into a position, and a market (and asset within that market), which has been trending upward.  It is also an investment strategy for those that have been looking for an entry point to more comfortably take a position in something that has been rallying. In practice, what’s done is they take a position or add to a position at a predetermined price drop, typically defined in percentage.  The expectation is that the odds are now more on their side, and the dip is not a complete change in direction. The investor buys with the idea that it will resume its trend past its previous recent high. If it does not, there is comfort in knowing the potential for loss is less than it was prior to the dip.

Defining a Dip

The more successful investors are not arbitrary in recognizing a dip that is worthy of buying into. Their practice may include either following how an asset has been trading and recognizing that it has a rhythmic decline within a percentage range. Or, seeing an investment has fallen and then go back to measure its historic dips to see if the new decline is part of an upward pattern. The investor will look to pull the trigger only after a decline that is a percentage within the previous patterns.

The chart above shows the 20-year uptrend in AAPL.  The stock demonstrates consistent dips in its
uptrend that may have only disappointed a long-term dip investor a couple of times.

Probability not Perfection

There is no perfect investment strategy. What the investor or trader is looking to do is improve the probability for higher profit; there is no strategy where profits are certain.

Some traders will also look at other measures to help determine if the change in direction is more likely to take hold. This could include whether the dip came with increasing volume of transactions or declining. They will look to see if the average is higher or lower on up days compared to when its retracing previous gains. Other popular methods for choosing an entry point or even whether to enter after a dip are standard tools found on most online broker trading packages, such as moving average crossovers, Bollinger bands, MACD, and a host of more complex measurements and stochastics.

Pitfalls

It’s important to know as much about a company and the industry as you can before committing capital. A stock that has dipped 20% from $10 to $8 might fit all the criteria to being a buy, yet a simple read of an analyst research note might indicate this isn’t a dip, but instead part of a bigger drop. It could even suggest that the outlook is less hopeful. Understanding the fundamentals of the company could help avoid some bad trades. The price may have fallen because it lost a big contract, involved in a lawsuit, revised earnings projections, management changes, competition, and so forth. That 20% drop might be just the beginning.

Managing Risk

The better trading strategies and investment styles include a form of risk control.  When buying an asset after it has declined, traders and investors generally define what the scenario looks like if it isn’t working out. In other words, they use past history and expectations to determine if the investment is not acting as anticipated. If it keeps going down, it trades sideways (tying up capital), or breaks other rules the trader may have set for themselves related to the position, they may need to exit.  

Buying the dips or “buy low, sell high” only works if you can sell high. If the stock is no longer in an uptrend, if it is making lower highs after each pullback, then there may be a more productive place to put your money.

Take-Away

Buying the dip or adding to a position on pullbacks is a trend that can be profitable but not guaranteed. It is best in long-term uptrends. As with anything else, the more going in your favor, the better. Overall, probabilities should increase if the overall market is also trending up, the industry is trending up, and the is economy accelerating. As with any strategy, a clear, purposeful plan and exit strategy is advised.

Dip buying can lower the investor’s average cost of a position over those who are prone to chasing investments. Supplementing any chart strategy with fundamental analysis or any fundamental analysis strategy with using a chart to create a dip strategy is also smart policy.

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