What does Buy The Dip mean for the long-term investor

Description of the Buy The Dip strategy

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The Buy The Dip principle is based on the belief that the market is rising over a long time horizon and that any decline will sooner or later be offset. An investor who follows a buy the dip strategy stays out of the market most of the time. He keeps a large supply of cash and waits for the moment when the value of the shares of companies of interest to him (or the market as a whole) begins to fall.

This approach owes its popularity to the long bull market that has been going on intermittently since 2009. In this cycle, any decline in quotations lasts for a short time, and after it, the indices update the historical maximum. Another reason is that the Buy The Dip strategy does not require fundamental analysis. A paper that has fallen too much can rise in price simply due to a technical rebound.

How the Buy The Dip strategy works

 

Two “bottoms” are clearly visible in the figure. By buying on the first of them, an investor could make about 20% profit in less than a month. At the same time he would not have needed to spend time studying companies’ reports and analyzing prospects. It was enough to buy an index fund. The second bottom gave another 10% in 3 weeks.

It is beautiful pictures like this that excite the imagination of newcomers, supporting the popularity of the Buy The Dip strategy.

The approach doesn’t only work in times of global crises. Each individual company may face temporary setbacks, unforeseen circumstances, etc. Negative news will cause its quotations to fall. This point is also used to implement the Buy The Dip strategy. But in this case it already requires from the investor to apply certain efforts. If you want to trade according to this principle you will need to make a list of companies with good fundamentals which can handle the factors which caused the drawdown. You will know that they will be able to return to their previous quotes, and buy back only them.

Two “bottoms” are clearly visible in the figure. By buying on the first of them, an investor could make about 20% profit in less than a month. At the same time he would not have needed to spend time studying companies’ reports and analyzing prospects. It was enough to buy an index fund. The second bottom gave another 10% in 3 weeks.

It is beautiful pictures like this that excite the imagination of newcomers, supporting the popularity of the Buy The Dip strategy.

The approach doesn’t only work in times of global crises. Each individual company may face temporary setbacks, unforeseen circumstances, etc. Negative news will cause its quotations to fall. This point is also used to implement the Buy The Dip strategy. But in this case it already requires from the investor to apply certain efforts. If you want to trade according to this principle you will need to make a list of companies with good fundamentals which can handle the factors which caused the drawdown. You will know that they will be able to return to their previous quotes, and buy back only them.

In addition, you need to determine for yourself exactly what level of correction you consider appropriate for a drawdown buyback. The supporters of the Buy The Dip strategy do not give a definite answer to this question. For some, 8-10% is a signal to buy, while others expect a fall of at least 25-30%.

Over the past six months on the Amazon quotes chart, you can see several good points to enter on a drawdown.

amazon

 

hey could be used by those with a short-term speculative strategy and those who are interested in long-term investing but are not ready to buy more than $3,000 worth of this company’s stock.

Pros and cons of the Buy The Dip strategy

The main disadvantage of the Buy The Dip strategy is that it only works when executed perfectly. In reality, few people manage to guess the bottom. In the case of massive market drawdowns, most investors begin not to “buy the bottom” but to “catch the falling knives”. It means that they buy some shares or an index, when the quotes are still far from their local minimum, and then they have no money left to build up their position.

More cautious investors don’t have time to buy back the drawdown (as you can see on the charts, the recovery can be quite fast). They enter into a position, when the quotes have already won back a noticeable part of the fall, which means that their profit will be much less than the potential one.

In addition, there is always the risk that the moment chosen to buy is not the bottom, but the beginning of a bear market.

If you are not waiting for a global crisis and a general market drawdown, but are working with individual stocks that have fallen on negative news, you may not guess with the issuer.

Conclusions

The Buy The Dip strategy doesn’t work well on a long-term time horizon. You have to wait a long time for a drawdown that will allow you to make a really good profit, and you may not be able to guess the bottom. By buying stocks regularly, you won’t miss market growth and will have a source of passive income. The optimal strategy is a combination of the 2 methods. I believe that you should regularly deposit money into your account, but also have some spare cash in reserve to take advantage of “tasty” prices.

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