What Does “Buy the Dip” Mean?
- Real Vision
- August 8, 2022
- 9:35 PM
Buying the dip is a common phrase used among stock traders. It is when investors get into the stock market after a period of considerable decline. Stock prices tend to be lower than usual when the market is in a slump, and many investors will buy into the dip to make a quick profit. You will often see online messages and articles talking up the benefits of buying the dip, but is it a good investment strategy? Learn more about this phrase and what it means in practical terms.
What is Buy the Dip?
Buy the dip refers to a situation where new investors come into the market while it is underperforming. When the stock market is low, some stocks may be undervalued. Investors will typically buy stocks with lower-than-usual prices and then sell them at a later date for a profit once the market has returned to its normal trading average.
Buying the dip can refer to either day trading or swing trading, which is when the trader holds onto the stock for more than one trading day.
A dip in the market can feel like a sale. Stocks are trading at lower values, which make them seem like a bargain to traders. The trader will then have to guess which way the stock is heading. Traders that buy the dip typically try to stay ahead of the curve to ensure they sell the stock at the right time. They compete with millions of investors, many of whom use sophisticated AI-powered programs to estimate when the market will rebound.
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What Does Buying the Dip Mean?
Buying the dip is simply another strategy for playing the stock market. Instead of looking for great companies that have bright futures ahead of them and buying/selling stock based on the company’s overall performance, traders focus on timing in the market.
Investors will enter the market when prices have fallen when buying the dip, but investor confidence will drive the market up and down over time. And predicting where the market will go next can be a fool’s errand. The market could further decline, which means the trader will lose money. The market could also rise, leading to a profitable trade.
Buying the dip becomes a guessing game. In fact, investors are usually encouraged to buy on dips when prices are lower than usual, but many trades will not go in the investor’s favor, which is why buying the dip by itself isn’t always a winning strategy.
When to Buy the Dip
A dip in the stock market is when security prices drop in the short term after a sustained upward trend. In most cases, the stock price will fall due to poor investor confidence. A major world event or economic disruption could force the market into a nosedive.
Stock prices are always rising and falling, so how do investors know if the dip is a good opportunity?
When buying the dip, investors look for companies whose stock is falling due to broad market fears. The drop in price should be unrelated to the company’s overall performance. If the dip is related to economic performance, the stock likely won’t return to its original trading value. In other words, the dip shouldn’t be caused by the company itself. It should come from overall market fears.
How to Buy the Dip
The direction of the stock market can be extremely difficult to predict. Stock prices will continue to drop or rebound until they reach their normal trading levels.
That’s why traders buying the dip are usually encouraged to buy and hold for the long term as opposed to short-term trading. If the market is in a slump, it will usually return to its normal trading average, but making up any recent losses could take months, if not years. In most cases, it is best to hold onto the stock until it has returned to its normal trading average.
For example, if a company has returned 20% annually for the last 20 years, the stock will likely return to its original position once the market recovers. This is known as reversion to the mean. Traders may even make more than 20% if they hold onto the stock until the market is on the upswing again.
This buying-the-dip strategy essentially combines two schools of thought. The trader looks for deals when the market is in a slump, but they will also consider the company’s overall financial performance. The trader will buy stocks in companies they believe are positioned for long-term success. This increases the chances of the stock returning to its normal trading average.
Buying the dip with short-term trading can be a risky exercise. Traders often have trouble knowing when the stock will rise and fall. Time in the market is usually more important than timing. Holding onto these stocks long term increases the chances of the stock increasing in value.
Is It Time to Buy the Dip?
Traders may want to consider buying the dip when the stock market is on the decline. Stock prices should be low across the entire sector. The decline should also affect other companies, not just one stock in particular.
It’s also helpful to buy the best stocks in a particularly hard-hit sector of the economy. Traders should consider investing in the best couple of stocks within the sector with the expectation that it will eventually recover as the market improves. These stocks are likely to return to, if not surpass, their normal trading values once investors feel more confident in the market.
Traders can also buy the dip with an index fund, such as those based on the S&P’s 500 Index or the Dow Jones Industrial Average. These funds give the investor a stake in hundreds of successful companies. The funds are directly tied to the overall health of the stock index. They tend to be low when the market is in a dip and high when it is doing well. Investors can put their money in index funds instead of researching individual companies.
Buying the dip is a common strategy for investors. It doesn’t make sense to buy stocks when they are high, so it’s usually best to enter the market when it has declined after a period of growth. Investors normally like to focus on investing in companies that will outlast the temporary downturn, including those with long histories of strong returns. When buying the dip, there’s always a chance the market could further decline. But investors should avoid selling too soon or risk missing out on potential returns once the market has fully recovered.
The stock market is always rising and falling. A dip can be a great opportunity to make money, considering the market almost always returns to its previous trading position. Investors should remember to stay cool when buying the dip. They should try to hold onto their stocks over the long term even if the market suffers a temporary setback.