What is 'Buy The Dips'
"Buy the dips" is a slang phrase referring to the practice of purchasing stocks following a decline in prices. After a significant dip in the price of a security or stock index, investors should increase positions or purchase different stocks to capitalize on what is seen as an eventual upswing.
BREAKING DOWN 'Buy The Dips'The concept of buying dips is based on market fluctuation. By purchasing stocks after a dip, investors are essentially buying shares at a discounted sale price. Like all trading strategies, buying the dip is not a sure thing, because some stock price drops are due to negative changes in the underlying company's fundamentals. For example, investors who followed this strategy around the bursting of the dotcom bubble may have lost money because internet companies lacked a revenue-generating business model. Buying the dips only seems to work when the market is oversold.
What Is a Dip?
Buying the dip means buying stock when the price reaches a low, when the stock experiences a significant drop in price. The degree of significance depends on the price range of the stock, but on average, a larger dip can mean a greater opportunity. The conundrum for traders is timing the reversal, which is very difficult.
On the morning of June 24, 2016, stocks plunged as investors digested the news that the United Kingdom had voted to exit the European Union, also referred to as Brexit. As of 10:35 a.m. (EST), the Dow Jones Industrial Average (DJIA) fell 2.2%, while the Standard & Poor's (S&P) 500 dipped 2.4%. The pan-European STOXX 600 index closed down approximately 7%. Investors may be concerned about this dip, but some traders look at this as a buying opportunity. For some, this is an opportune time to buy the dip because it is an irrational selloff; for others, it represents a fundamental price change based on the new value of assets in a post-Brexit world.
Buy The Dip Theory
Two concepts that support buying stocks on dips are reversion to the mean and market sentiment. Reversion to the mean tends to apply to auction markets, especially when the price of assets and commodities is too high or low. All other things equal, outliers such as dips must revert back to the middle or average price.
Market sentiment is the notion that the price of assets is driven by emotion and fundamental value. Sometimes, market sentiment pushes prices to extremes before the prices revert to the mean. Both theories support what traders have been saying all along: buy the dip, sell the rally.