What is a 'Buy The Dips'

Buy the dips is slang for purchasing stocks after a decline in prices.

BREAKING DOWN 'Buy The Dips'

Buying the dips occurs after there has been a significant dip in the price of a security or stock index. Investors practicing this method will increase positions or purchase these newly lower-priced stocks to capitalize on what they hope will be a coming upswing in prices.

The concept of buying the dips is based on the theory of market fluctuation. When an investor purchases stocks after there has been a dip, they are purchasing shares at a discounted price. These investors are counting on the market rebounding and being able to take advantage when the price reverses. Investors could potentially garner a large return on investments made using this strategy.

However, like all trading strategies, buying the dips does not guarantee an investor will profit. Stocks can drop for many reasons, including changes to the underlying value of the financial instrument. Investors who were buying the dips during the subprime mortgage crisis may have experienced great losses as those prices dropped but never rallied. Buying the dips appears to be most profitable when the market is oversold.

The theory behind buying the dips is that eventually, barring extreme circumstances, the market will eventually rally and return to pre-dip prices. This is the fundamental idea behind the trading theory of buying the dip and selling the rally.

An Example of Buying the Dip

Consider again the example of the subprime lending crisis that happened in the mid-2000s. During this time, many mortgage companies began to see their stock prices plummet as they were unable to meet their margin calls. 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 the 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 shuttered 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 down to below a dollar per share.

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