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Buy The Dip

Buy The Dip

Summary:
  • Cost averaging beats buying the dip over the long term.
  • With 10% threshold BTD only works 26% of the time
  • Buying the dip only works if the asset is fundamentally sound
  • Not all dips are made the same

The saying/quote of "Buy the dip" is one we see time to time get thrown around social media with, again, not much context behind the saying. I am not saying that buying into a position is bad but there are many variables to think about before purely buying into a "dip". Also what about the famous "time in the market over timing the market", this quote is for another day.

What does buying the dip really mean?
Buying the dip means purchasing an asset after it has dropped in price, normally a asset which is already owned. The dip which is presented at the time is believed to be the new lower price and represents value or a bargain, from where the price was before. Buying the dip normally is represented with a short term blip in the assets price and with time, is likely to bounce back and increase in price.

Buying long term into an asset on a short term price basis.

There are 3 cases for buying a dip:
  1. Assets with a long term uptrend, the short term decline of the asset presents an opportunity before resuming the upward trend.
  2. The dip in the assets price presents an opportunity for a future uptrend. Buying when low in order to profit from some potential future rise in stock price
  3. When a asset is already held and buys on the dip, averaging down in price for the long term.
Lets look at some data.
Here we will look at some graphs which prove buying the dip can out perform cost averaging but also the other way round.

Looking at data from 1970 to 1990, over this 20 year span of the stock market, the strategy of buying the dip will in fact beat cost averaging, but not by a huge margin. For the Buy the Dip strategy you save cash until the market is below 40% of its all time highs where cost averaging you invest $100 every month.
im-404476
Around 1974 the market dips and falls bellow 40% of ATH and then invests the money, compared to cost averaging which is every month.
im-404475

From this graph we can see that the buy the dip strategy is only active for 2/3rds of the time frame.​

This is one example where buying the dip works, but sadly there are many more periods of time where buying the dip simply doesn't work. From the year 1980 to the year 2000, even if we increase the drawdown to 50% for the buy the dip strategy, you would have been sat on cash for almost 20 years.
im-404481
As you can see that Cost averaging has majorly out performed due to not timing the market.
Buying the dip obviously shows its not a useful strategy when investing for the long term. Here is further evidence of the little chance of success in the strategy. Here in this illustration we compare the dip thresholds and how often buying the dip out performed cost averaging:
Dip thresholdHow often buy the dip outperforms cost averaging
10%26%
20%26%
30%27%
40%33%
50%38%


Now we have proven that buying the dip doesn't work as a strategy as a whole, why is it still advocated for?
If buying the dip is not the strategy being used, then what help is the generic advice of buying the dip going to do?

In my honest opinion, its not a lot of use and in fact can be dangerous. Not all dips are made the same! On top of that is the dip you calling out really a dip or simply a support before breaking that?

I am not against buying the dip but simply the advice of it given out, as I've said, not all dips are made the same. You typically find there is a cause for a dip, whether in a equity or market, there is one cause or another. Because of the variety of the causes this mean not all dips are made the same.

When a dip in a market, such as the S&P500, there is normally a reason and for a whole market to move there typically has to be a large reason. There could be economic news, political news or simply fear in a market. Just as with an overall market, individual stocks (equities) can have the same. They can come out with news of a new CEO, maybe for a less favourable one, latest financials (possibly missed estimations), a law suit and more.

These are some reasons for a market or asset to act negatively and for the stock price to fall. There can be cases where an event is oversold and investors sell out of fear rather than rationality. This would be an example of a kind of dip to buy into, when it is unjust. This is compared to a company who may have released earnings and miserably failed thus a sell off of the stock. Would this still be a buy even though the fundamentals have changed?

This is where the dips are not made the same and as an investor it is down to you to figure out whether the latest dip is justified or not, whether to buy the dip or that the dip makes sense.
Blindly buying into a dip for the dips sake is not a sound or reliable investment strategy.

Lets take a look at a good example of a bad example of buying the dip.
Nikola Corp, once a hyped up growth stock, ready to take on the world of EVs.
Lets look at their 1 year chart.
Screenshot 2022-01-14 143703.png
You can basically pick any point on this graph and nowhere can you prove that buying the dip was a good idea. Even if you bought at the dippiest dip there is on this chart you would not have recovered or made a substantial amount to make it worth while of an investment.

Now lets look at another car marker which is moving into the EV area which, as of the last year, has paid off. Ford for the past 5 years has been trading sideways with the largest dip in 2020 going down to under $5 a share. In the last year its moved from $10 a share to $24 a share.
Screenshot 2022-01-14 144111.png
Congratulations, you've managed to wait it out and have been rewarded significantly. But I still question the effectiveness long term and such events of buying the correct dip and that it does not dip further is something that no one can truly predict.

The questions to ask:
  • Index or Equity?
- Indexes are more reliable to buy the dip where equities require more research.
  • How much cash you have?
- How many dips can you endure with your cash to make it worth while and how many opportunities have been lost to holding cash.
  • Is the dip justified?
- If the dip is not justified is it an opportunity to take advantage of? If its justified then is it something to be worried about. Risk tolerance and type of investment comes into play.
  • Does Buy the Dip strategy apply to me or increase my emotional risk
- That's right, thinking about buying the dip can increase your emotional risk. Cost averaging and not constantly looking at your portfolio can help you perform best long term.