“Buying the dips” refers to purchasing assets at discounted prices after they have fallen in value, in the hopes that this new price is a bargain and that, over time, these assets will quickly rebound and gain value again.
“Buy the dips” is an often heard phrase among investors and traders when an asset’s price declines temporarily, giving some an opportunity to purchase or add to existing positions at lower prices than before the decline. This approach to investing stems from price waves; when an investor purchases assets after price declines they purchase them at reduced costs with hopes that when markets rebound again their investments may yield profits.
Buying the dips can have many different applications and outcomes depending on the circumstances. Some traders believe they can profitably buy any asset which drops within an uptrend but subsequently returns; these traders see these dips as opportunities to buy and expect that once an asset goes back uptrending they will continue.
Others utilize this phrase when no secular uptrend exists but they recognize one may emerge in the future, so they buy when prices drop to capitalize on any future price rises that may occur.
Assuming an investor is already long and purchases on dips, they are said to “average down,” an investing strategy which involves purchasing additional shares after prices have declined further, leading to a lower net average price overall. If dip-buying doesn’t later result in an upswing, however, then this type of buying could add “washout.”
Limitations Of Buy The Dips
As with any trading strategy, buying the dips doesn’t guarantee profit. An asset’s price can decrease for various reasons, including changes to its underlying value; just because its cost has reduced doesn’t guarantee that it represents superior value.
Issue: An average investor typically does not possess the knowledge to distinguish between temporary price drops and signs that prices will significantly decline in future. While there may be unseen intrinsic value present, buying additional shares solely to lower an investor’s total expenses of ownership is no valid justification to increase his portfolio’s exposure to any one stock’s price action. Proponents of this strategy view it as a practical approach for wealth accumulation while detractors see it as potential disaster waiting to occur.
An $8 fall may offer an attractive buying opportunity; but, realistically speaking, it probably won’t. There could be valid reasons why the stock has declined such as changes to earnings or growth prospects; management changes; poor financial conditions or contract losses which resulted in further decreases. It may continue to drop until it eventually hits zero as soon as conditions deteriorate sufficiently.
Managing Risk When Buying The Dip
All trading strategies and investment procedures should include some form of risk control. When purchasing assets that have dropped significantly, many traders and investors establish an entry price to manage risk when purchasing. For instance, when an asset falls from $10 to $8 in price, a trader might establish an entry price to avoid losing too much at once should it reach $7; they anticipate the asset going higher from $8 and are buying as a hedge against further decline – yet also wish to limit any further losses should their assumption prove incorrect and the asset continues to decrease further.
Purchase of dips can often work well when investing in assets in uptrends. Dips, also called pullbacks, are an integral part of an upward movement and as long as price action continues making higher lows on dips while making higher highs again on subsequent trending moves, the uptrend remains intact.
Once prices begin making lower lows, they have entered into a downtrend and prices will become cheaper as each dip follows with lower prices. Most traders would rather avoid purchasing assets during such downtrends; however, long-term investors who see value in such low prices might benefit from doing just that.