When you “buy the dip,” you buy an asset after its price drops on the hopes it will recover quickly. While this strategy can lower your average buying costs, it’s also a form of risky market timing.
Buying the dip simply means that you buy an asset when its price declines, or dips. Buying during price declines can lower your purchase price and help capture larger returns when (if) the price rises again.
Many investors use dips as a chance to increase ownership in long-term holdings at a discount. In these cases, dip buying may be incorporated into a dollar-cost averaging or buy-and-hold strategy. As the investor buys more shares at bargain prices, they “average down” investment costs and smooth over negative volatility.
But some traders buy dips as a short-term or standalone strategy. They often store up cash or liquid assets and wait for an asset or index’s price to decline. They may also set price minimums or maximums to guide their trading windows. When prices drop, they swoop in – and when prices recover, they cash out just as quickly.
Traders and investors buy dips all the time – but a few notable examples stick out.
During the 2008-2009 financial crisis, major indices plunged in response to a volatile economic depression. While many investors’ portfolios tanked, a few took the opportunity to buy the dip anyway.
For some investors, the strategy worked. For instance, if you bought Apple at $3 per share in January 2009, you could have cashed out at $182 a share in January 2022.
But that wasn’t always the case. For example, investors who bought into drowning institutions like Lehman Brothers, Bear Stearns, or Washington Mutual saw their portfolios gutted when these companies closed down.
The above example perfectly exemplifies the risks of buying the dip.
On one hand, buying the dip can lower your total purchase costs while increasing your holdings. In short-term bursts, the strategy can even outperform dollar-cost averaging.
However, buying the dip also encourages risky behaviors like market timing and stock picking. And because you need to stash cash for your purchases, you may miss valuable growth waiting for an unguaranteed discount.
Plus, even if a dip does occur, you might still buy the stock at a premium compared to last year’s price. Short-term dip-buying can also hike your trading fees and capital gains taxes while skipping over dividend reinvestment opportunities.
The primary benefit of buying the dip is reducing your average purchase price. However, because it relies on market timing and potentially stock picking as well, it presents unique risks. Attempting to predict any market movement is impossible and encourages irrational, emotional decision-making.
At Q.ai, we tend to advocate against market timing and emotional investments. A buy-and-hold strategy is likely to see greater success (or fewer losses) than riskier methods.
That said, we also recognize that there’s potential for working dip buying into a long-term investment strategy. So, when an otherwise-winning investment gets down on its luck, we won’t judge if you invest a little more to take advantage of the opportunity.
Q.ai is the trade name of Quantalytics Holdings, LLC. Q.ai, LLC is a wholly-owned subsidiary of Quantalytics Holdings, LLC ("Quantalytics"). Quantalytics offers automated financial advice tools through Quantalytics Investment Advisors, LLC ("QAI"), an SEC-registered investment advisor. QIA’s investment advisory services are ONLY available only to residents of the United States. Disclosures concerning QIA’s investment advisory services are available on its Form ADV filed with the SEC. The content in this newsletter is for informational purposes only and does not constitute a comprehensive description of Q.ai's investment advisory services.