What is Buy The Dips?

Buy the dips refers to purchasing an asset after it has declined in price. Buying the dips has different contexts, and different odds of working out, depending on the situation in which it is utilized. Some traders may say they are buying the dips if an asset is in a long-term strong uptrend. They hope the uptrend continues after the dip or drop. Others may use the phrase when no uptrend is present, but they believe an uptrend may occur in the future. Therefore, they are buying when the price drops in order to profit from a potential future price rise.

Understanding Buy The Dips

After the price drops from a higher level, some traders and investors view the drop as an advantageous time to buy the asset or add to an existing position.

The concept of buying dips is based on the theory of price waves. When an investor purchases an asset after there has been a drop, they are buying at a lower price. These investors are counting on the market to rebound and thus they will profit if higher prices come.

Like all trading strategies, buying the dips does not guarantee an investor will profit. An asset can drop for many reasons, including changes to the underlying value of the financial instrument. Just because the price is cheaper than it once was doesn't necessarily mean the asset is a good value.

A stock that falls from $10 to $8 may present a good buying opportunity, but it also may not. There could be a good reason why the stock dropped, such as a change in earnings, dismal growth prospects, a change in management, poor economic conditions, loss of a contract, and the list goes on. It may continue to drop...even all the way to $0 if the situation is bad enough.

Key Takeaways

  • Buying the dips refers to buying an asset after it has declined in price.
  • Buying the dips can be profitable in long-term uptrends, but unprofitable or tougher during downtrends.
  • Consider how risk will be controlled when buying the dips.

Managing Risk When Buying the Dip

All trading strategies and investment methodologies should have some form of risk control. When buying an asset after it has fallen, many traders and investors will establish a price for controlling their risk. For example, if a stock falls from $10 to $8, the trader may decide to cut their losses if the stock reaches $7. They are assuming the stock will go higher from $8, which is why they buying, but they also want to limit their losses if they are wrong and the asset keeps dropping.

Buying the dips tends to work better in assets that are in uptrends. Dips, also called pullbacks, are a regular part of an uptrend. As long as the price is making higher lows (on pullbacks or dips) and higher highs on the ensuing trending move, the uptrend is intact.

Once the price starts making lower lows, the price has entered a downtrend. The price will get cheaper and cheaper as each dip is eventually followed by lower prices. Since most traders don't want to hold onto a losing asset, buying the dips is avoided by most traders during a downtrend. Buying dips in downtrends may be suitable for some long-term investors who see value in the low prices.

An Example of Buying the Dip

Consider the subprime lending crisis that happened in the mid-2000s. During that time, many mortgage companies began to see their stock prices plummet. Bear Stearns and New Century Mortgage were among the lenders who experienced significant and steady declines on stock prices during this time. An investor who routinely practiced a buying-the-dips philosophy may have grabbed up as many of those stocks as they could get their hands on, assuming that the prices would eventually rally and revert back to their pre-dip levels.

However, that never happened. Instead, both of those companies eventually shut their doors after losing significant share value. Shares of New Century Mortgage, for example, dropped so low that the New York Stock Exchange (NYSE) had to suspend trading on their shares. Investors who thought the $55 per share stock was a bargain at $45 would have found themselves unable to unload the stock just a few weeks later when it dropped below a dollar per share.

On the flip side, between 2009 and 2018 shares of Apple (AAPL) went from around $13 to over $230 briefly. Buying on the dips during that period would have rewarded the holder handsomely.