What is Buy The Dips?

"Buy the dips" is a common phrase investors and traders hear after an asset has declined in price. Buying the dips has several contextsand different odds of working outdepending on the situation. Some traders say they're "buying the dips" if an asset drops within a long-term strong uptrend. They hope the uptrend will resume after the drop. Others 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 an asset's price drops from a higher level, some traders and investors view this as an advantageous time to buy or add to an existing position. The concept of buying dips is based on the theory of price waves. When an investor buys an asset after a drop, they are buying at a lower price. These investors are hoping to profit if the market rebounds.

Like all trading strategies, buying the dips does not guarantee profits. An asset can drop for many reasons, including changes to its underlying value. Just because the price is cheaper than before doesn't necessarily mean the asset is a good value.

A stock that falls from $10 to $8 might be a good buying opportunity, and it might not be. There could be good reasons 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 dropall 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 with 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 followed by lower prices. Most traders don't want to hold onto a losing asset and avoid buying the dips 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 2007-08 Financial Crisis. During that time, the stocks of many mortgage and financial companies plummeted. Bear Stearns and New Century Mortgage were among the hardest hit. An investor who routinely practiced a "buy the dips" philosophy would have grabbed up as much of these stocks as possible, assuming prices would eventually revert to pre-dip levels.

This, of course, never happened. Both companies shut their doors after losing significant share value. Shares of New Century Mortgage dropped so low that the New York Stock Exchange suspended trading. Investors who thought the $55-per-share stock was a bargain at $45 would have found themselves with steep losses just a few weeks later when it dropped below a dollar per share.

On the flip side, between 2009 and 2020 shares of Apple (AAPL) went from about $3 to more than $120 (split adjusted). Buying the dips during that period would have rewarded the investor handsomely.