Buying the dip can make you either rich or remorseful. So, how do you increase your odds of success? Read on.
The Russian invasion of Ukraine threw the stock market into a frenzy. Oil prices shot up, with one barrel costing over US$100 for the first time since 2014. The cost of food grains, including wheat and soybean, rose, as did the fear among investors. While gold prices surged, many others fell sharply, thus resulting in investors losing huge sums of money. Where many saw—and experienced—losses, some saw opportunity. They decided to buy the dip.
The Chief Investment Officer at Tuttle Capital Management, Mathew Tuttle, observed, “There are a lot of people talking about buying the dip so I’m sure there are a lot of portfolio managers out there with shopping lists.” These lists include Russian and Ukrainian assets that have taken a major fall this month. In fact, any time the market falls, investors rush to buy some of the most favored stocks at low prices. However, that’s not always a good idea.
But first, what does it mean to “buy the dip”?
Typically, when you buy the dip, you are investing in a security that has experienced a decline in price. Thanks to that, you are buying it at a bargain cost. You are hoping that the security will rebound and that you will be able to sell it at a higher price than what you bought it at. The Director of Behavioral Finance and Investing at online investment firm Betterment, Dan Egan, sums it up best. He says, “It’s a way of minimizing regret and feeling comfortable with getting invested at a specific point in time.”
Rewards of buying the dip
You could attract large sums of money at lower risk. An assistant professor of Finance and Financial Engineering at Stevens Institute of Technology, Majeed Simaan, told Quartz, “Intuitively, it is equivalent to a policy that yields good returns while reducing the anxiety of watching your portfolio exhibit large drops over time.”
Risks of buying the dip
There is no guarantee of profits, as even though the asset might be more affordable, it could have lost its value. Due to that, it might not be profitable in the long-term. Additionally, Egan points out another issue that many investors might face with buying the dip. He expounds that using this strategy, “you can end up sitting out of the market for those long periods of time when it rallies.” You will keep waiting for the price to fall lower and lower, and you won’t know when to buy before it’s too late.
That said, experts feel that, to make the most of such opportunities, it helps to have an investment plan and some additional money set aside.
When should you buy the dip?
When you can be sure that the stock price will rise again. While there is no set way to do so, you can give due attention to the reasons behind the dip. Was the dip because of the company’s performance or market fears? Next, gauge the quality of the company. Was it a big, established company or a relatively small one? Large companies, usually, have a tendency to bounce back given their standing in the market.
Lastly, don’t just buy the dip because your peers are doing so. Do your own research. Check out the balance sheets of the company and its long-term profitability.
A survey revealed that, in 2020, the third-most popular reason for people opening bank accounts was to buy the dip. Naturally, it is an appealing choice and can be profitable, too. If done correctly, following this strategy can lead to a lower-risk portfolio. Just make sure you take all the necessary precautions and understand all the risks involved.
When it comes to buying the dip, it’s important to remember that there is no one-size-fits-all answer. What might be a good idea for one person might not be as good for another. So, it’s crucial that you assess all your options and make a decision that is best for you.
Header Image by Pixabay
