Experiencing a decline in the financial market doesn’t necessarily spell disaster for investors with long-term goals. Instead of hastily selling off investments, downturns like the ones witnessed in 2022 and 2023 could present an opportunity for investors to maintain their unwavering commitment to their portfolio. In fact, downturns may even present an opportunity to “buy the dip,” or invest at a discount!
What Does It Mean to ‘Buy the Dip’?
“Buy the dip” is an investment strategy based on the simple concept of ‘buying low and selling high’, but with a more focused approach. The success of this approach depends on two key elements: a significant drop in stock prices and a strong indication that they will rebound. A good example of this is when a large corporation’s stock price abruptly drops due to broader market fears instead of any long-term concerns about the company.
By definition, ‘buy the dip’ is a short-term strategy and not associated with long-term investing. When making a purchase based solely on recent price drops, investors are essentially engaging in market timing.
Without pre-established guidelines, determining the appropriate size of a dip can be hard. Therefore, ‘buy the dip’ isn't a good long-term investment strategy. The bigger the dip, the bigger the potential gain, but stocks that experience significant drops may also have underlying fundamental shifts that prevent them from hitting their previous highs.
The ‘Buy the Dip’ meme:
The concept of “buy the dip” has become popularized through internet memes, particularly in the realm of volatile cryptocurrencies like Bitcoin and meme stocks such as GameStop. However, an example of the limitations of this strategy can be seen in a famous instance of the “buy the dip” meme involving Nayib Bukele, the pro-Bitcoin president of El Salvador.
On May 9, 2022, Bukele announced on Twitter that El Salvador had purchased 500 Bitcoin at an average price of around $30,744, during a time when the cryptocurrency had dropped over 25% in value over the previous month. Unfortunately, the price of Bitcoin continued to experience a volatile decline, underscoring the inherent risk of utilizing a “buy the dip” strategy.
Find out what is Bitcoin’s Satoshi and how it is calculated!
Is it a good time to apply ‘Buy the Dip’ strategy?
The latest data from the investment service group Bespoke suggests ‘buy the dip’ is on its way back. Based on Bespoke’s report to clients, investors who have been following this strategy have begun to see positive results once again.
According to the report, the popular S&P 500 index ETF (SPY) has generated an average return of 0.30% on trading days following price declines since 2023. The return on this investment is almost as high as what was seen in 2020, a particularly successful year for dip buyers.
According to bespoke analysts, SPY gained 0.32% on the day after a down day in 2020, which was its best performance of this kind ever. During 2023, SPY fell only 0.04% on days following price increases. With up days followed by average losses of about 0.1%, this is a smaller decline than what was seen in 2020.
However, the S&P experienced declines on both up and down days in 2022, which was a poor year for stocks overall. The “buy the dip” mentality seems to be making a strong comeback now that stocks are showing signs of recovery following down days, according to Bespoke researchers.
How does the ‘Buy the Dip’ strategy work?
To buy the dips, you need to hold some cash or low-risk assets outside the market and wait for the prices of stocks, bonds, index funds, or cryptocurrencies to fall. Once prices drop, you can use the cash to purchase more of the asset, reducing your overall average cost and potentially increasing your returns if the asset value increases over time.
If you had kept cash on the sidelines before the March 2020 crash, you could have purchased cheap shares of Vanguard’s S&P 500 ETF and enjoyed high returns. However, predicting market dips is difficult, and buying at the right time requires some luck and confidence in the asset’s potential for recovery.
Buying dips in the cryptocurrency market is different due to the lack of standardized valuation metrics and the speculative nature of digital assets like Bitcoin. Investing sooner or holding on for a longer period may not increase your chances of making a profit, and there are no associated dividends to miss out on.
When considering buying cryptocurrency, it’s crucial to understand the risks and create a diversified portfolio comprising different asset classes.
How to manage risks when you ‘Buy the Dip?
The following points are worth keeping in mind if you decide to try to buy the dip on a particular index or security:
- Keep only a small percentage out of the market. Maintain a modest amount of “dry powder” — around $5,000 to $10,000 for every $50,000 you invest.
- Decide at which point you are willing to deploy money. Make sure you are prepared to buy more shares if a stock declines 10% in advance. It may take a long time for further drops to appear.
- Don’t leave money uninvested. If you don’t know what you’re giving up and why, you’ll lose out on favorable tax treatment and qualified dividends.
- This is an unorthodox strategy for generating reliable after-tax returns. Though buying dips might seem wise, in the vast majority of cases, you’re best off staying fully invested. A portion of your portfolio might be held in cash, depending on your asset allocation. Learn why ‘cash is king’ during economic downturns!
One could argue that ‘buy the dip’ is a sound investment strategy for many psychological reasons. To become a successful long-term investor, you must learn to overcome these psychological and emotional biases. If you decide to buy the dips, you should do so in moderation and fully understand the risks. Alternatively, you should develop a risk-adjusted portfolio that considers both your short- and long-term goals. It’s likely the “future you” will not be disappointed!
How to ‘Buy the Dip’?
A ‘buy the dip’ investment strategy proving to be very successful in 2023 – the gains are almost as good as they were in 2020. Let me show you how to ‘But the Dip’!
1. Look at the most impacted sectors of the economy – You can diversify your investments across multiple economic sectors by purchasing an index fund that tracks the general market, such as the S&P 500. An index like the S&P 500, which includes 11 different sectors, can be used to implement a similar strategy.
2. Observe the drop in large companies – Blue-chip stock prices have declined recently as a result of inflation, the pandemic, and interest rate increases. This offers a chance to buy shares of big businesses for less money. Be cautious when choosing individual stocks, though, as they are more volatile and riskier than mutual funds, exchange-traded funds, and index funds.
3. Utilize dollar-cost averaging – Instead of making lump-sum contributions when it suits you, consider investing steadily at regular intervals. As a result of dollar-cost averaging, you will keep buying shares even when they dip.
In recent years, CFDs have gained popularity due to their plethora of markets, leverage, and flexibility. A stock CFD offers greater leverage than traditional trading, and the level of leverage varies from broker to broker. When a trader uses less capital with a low margin requirement, the potential returns will be significantly higher.