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"Buy the dip" is not a strategy.
Don't be a chart investor.
'Buying the dip' refers to purchasing a stock or an ETF during a decline that meets certain criteria, such as a fall in price from a recent high that is larger than average. On the surface, this sounds like a viable strategy, because you buy shares when prices are down. And who doesn’t want to save money on an investment, right? Not so much. Here’s the pitfall:
“Buy the dip” encourages investors to fall victim to the assumption that the uptrend will continue. This strategy is especially popular during bull markets when a market rally can be punctuated by multiple pullbacks in equity prices as stock prices march upwards. If we look at google search, we can clearly see an increase in search inquiries in the last 5 years.
It is no coincidence that such a strategy only becomes popular when we have an unusually long bull market and investors become too confident. And we know what overconfidence in investing can lead to.
When it comes to investment strategies, I follow a simple principle: What has worked in the past, and which approaches are still valid today? I have read dozens of old investment books and cannot remember "buy the dip" ever being mentioned as a successful investment strategy. What I do see on the other hand are YouTubers and TikTokers promoting this idea.
The fundamental assumption on which this strategy is based on is wrong. It focuses on the price as the first factor in making a buying decision, when the price should be the last one. First, you figure out if a stock is investable, then you figure out if a stock is a good investment. A quality compounder can be investable but not a good investment if it trades at a high price, even if it dips. Keep that in mind.
When you “buy the dip” you spend your money based on price fluctuations that are short-term sentiments. You are not an investor, but a gambler. When the price of a stock drops, your job is to find out why it dropped and if the drop is justified. Is it because the guidance has been lowered? Has a law been implemented that will affect earnings? Or are analysts just spreading fear so they can load up some shares for their own clients? Only then you can make an educated decision.
Investors who have been in the market after 2010 just don’t know how far a stock can fall. They tend to think that 20% is a big drop. By buying the dip just because a stock is cheaper, you neglect the financial reality of a company and jeopardize your money by catching an ever-falling knife. No wonder YouTubers spread this idea so often since they and their audience belong to the younger target group that has been investing for a couple of years.
“Buy-the-dip only works when you know that it was a dip.”
That’s why it’s always key to invest based on fundamentals and to do your research. Doing your homework before and checking if the company is still in a healthy state can be a powerful “buy the dip” strategy. A sharp decline in stock price can signal an investment opportunity if investors can accurately identify which dip to buy and when to buy it because not all opportunities are created equal. It is important to note that no one indicator can ever constitute a solid investment decision on its own, and “buy the dip” is no exception to this rule.
You sit in cash for too long
On top of that your opportunity costs are rising. How often have I heard from people that they are waiting for the big crash to invest really big? Their money sits in their account while their favorite stock goes up. During that time the owner of that stock enjoys dividends and a rising share price, while the “smart” guy waits on the sidelines. And when the market crashes, he hesitates because he thinks that the crash is not over only to notice months later that the new uptrend cycle has already begun, then he starts waiting for “the dip” again, and so on.
“Instead of trying to find the perfect time to invest, look for an opportunity that looks like more of a sure thing than others.”
Another problem with “buy the dip” is that it promotes an easy shortcut. Especially when it comes to Index Funds: “Just pick an Index Fund, buy each time the price drops 10% or more from its highs, then you will be fine because in the long run stock indexes are going up.” This is the usual argument. When something sounds too good to be true, it usually is. No wonder this strategy is so popular because it promises an easy solution for the lazy investor and unfortunately most investors are lazy. Indexes have been going up in the long run because a few exceptional stocks are lifting the rest of the mediocre ones up. What we can learn from ETFs and the dangers of ETF investing I will clear up in another Newsletter.
To sum up today’s topic:
“Calling a dip is different than seeing value. The former is a judgment about price and time whereas the latter is a judgment about price only. Buy when you see value because it's unlikely you will time the dip.”
Always take mainstream advice with a grain of salt. Hope you learned something today. Until the next issue. 👋