What is Buying the Dip?

Sun May 22, 2022, 01:24 pm | by Charles Munyi | No comments

Buying and selling: the two most popular terms when it comes to investing/trading. The general assumption is that you should buy cheap and sell high. However, that is not always the case. 

The reality is that there are several strategies investors use to stay profitable. One of those strategies is buying the dip. This article takes a closer look at this trading strategy and how to pull it off successfully.

Definition of Buying the Dip

Buying the dip refers to buying assets while the prices are on a short-term dip. The idea is that the slight price dip represents an opportunity to buy cheaply before the asset prices bounce back. The whole strategy relies on the theory of price waves. The theory states that prices are predictable because they move in repeating patterns.

Using corrective and impulse waves, investors analyze market trends and decide when to either buy or sell an asset. The traders then use the findings to anticipate a reversal. However, the insight from the wave theory is not meant to be certain. It merely provides probable outcomes. This investment strategy is only profitable for long-term investment but can cost investors money on the downtrends. 

Pros of Buying the Dip

Buying the dip is an investment strategy preferred by many investors. It is reasonably reliable when combined with technical analysis. Here are the advantages of this investment strategy.

It’s Repeatable

Timing the market is not always a manageable strategy. That is why many investors prefer safer approaches like buying and holding. Buying the dip relies heavily on mathematical models, which are pretty predictable. The time and price wave relationships Fibonacci ratios. For instance, corrective waves have a retracing 38% of the previous impulse.

Higher Profits

The whole reason for investing in stocks or crypto is to make profits. Buying the dip is an opportunity for investors to get in on the action at a considerably lower price. The hope is that they will sell the assets at a higher price when the market rebounds. From a long-term investment perspective, when continuing to purchase assets at a lower price, the overall cost average is reduced and therefore when an uptrend is observed, a higher return follows.

Cons of Buying the Dip

Buying the dip works, but like all trading strategies, it never guarantees 100% profitability. If you get it wrong, you might buy a position that is falling off a cliff. Here some of the limitations of buying the dip.

Slow Recovery

The key to making money by buying the dip is identifying a temporary drop in prices. Unfortunately, it can be challenging to know whether a dip is a short-term or a downtrend. If you get this wrong, you may end up with worthless assets. On the other hand, dollar cost averaging cushions the investor against volatility.

Risk of Missing Out

Buying the dip means you have to be constantly monitoring the market for pullbacks. Usually, you have a short window to decide if the drop is temporary or a warning sign. If you don’t invest and your analysis is incorrect, you will have missed out on an opportunity. 

How to Buy the Dip

Knowing about buying the dip is one thing but mastering how to invest effectively is a whole new thing. It involves doing copious amounts of research, identifying strong financial assets, and understanding how long the dip will last. Nevertheless, here is a breakdown of how to buy the dip and manage the risks.

1. Find Trending Stocks

The first step when buying the dip is to identify financial assets with a strong upward trend. The only way to do this is by studying charts of asset performance. It is not enough to look at the trend for an hour or a few days. Instead, look at the big picture. What is the trend over weeks or even months?

Stocks and securities rarely move in a straight line. They usually fluctuate up and down. There is no one method for identifying a trending stock. However, there are numerous methods investors can use to analyze a trending stock.

  • Bottom-up Approach: The easiest way to find a trending stock is to visit a respected stock market website or publication. You will find a list of top trending stocks setting highs and lows for as long as 52 weeks. Find one stock from the list and pull more data about it. If the stock shows that the price is steadily rising despite small fluctuations, then it’s trending upwards.
  • Top-Down Approach: This method involves using an online research service to find trending stocks. The stock research software lists trending stocks based on their formulas and algorithms. Investors can pick one stock from the top-performing industries and drill down for more data.

2. Determine If An Asset is a Good Dip Buy Candidate

After compiling a list of top trending stocks in step one, you will need to examine those assets a little closer. Just because a stock is trending doesn’t automatically make it a great dip buy. 

You can use various indicators such as price, volume, and momentum to conduct further analysis. Here the strategies for analyzing stocks before buying the dip.

  • Dollar-Cost Averaging

Dollar-cost averaging is an approach used by investors that prefer to hold the assets for an extended period. The process involves investing the same amount of money in an asset regularly rather than making a one-time investment at a specific price. 

Under this approach, the investor divides up the funds and acquires shares at regular intervals regardless of the price. The idea behind cost averaging is to reduce the overall impact of volatility of the price of the targeted assets. Committing to dollar-cost averaging ensures that investors don’t make unproductive decisions out of fear or greed.

  • Fibonacci Retracement

Fibonacci retracement applies the famous mathematical sequence formulated by an Italian mathematician. However, as an investment tool, it is not as complicated as it sounds. There are no calculations or analyses. All you have to do is connect two lines between a low and a high point on a chart. 

The chart is then subdivided into several Fibonacci percentages such as 23.6%, 38.2%, and 61.8%. Financial analysts consider these levels as potential points for the price could stall or reverse. While this indicator is useful, it does not provide any assurances. As a result, investors often have to use it together with other confirmation indicators.

3. Decide on a Trading Plan

All the work done finding the right trending means little if you don’t have a plan. You cannot make random trades and sit back expecting to be profitable. It is crucial to set goals for the trades and decide when you will get out beforehand. Smart investors also have a risk management plan in case things don’t go your way. Here some common strategies you plan 

  • Breakout Trading

This trading strategy utilizes resistance and support levels to determine when to exit a trading position. If a stock breaks the support level and continues to dip, that asset is no longer considered a good asset. It is usually a good time to exit a trade. 

Likewise, when assets move above the resistance level, investors expect them to continue their upward trend. However, this strategy sometimes doesn’t work because prices may move freely above and below the resistance levels.

  • Scalping Strategy

This strategy involves setting a threshold for buying and selling an asset before you enter into a trade. The investors then watch the prices of their asset closely as it moves in either direction. Scalping requires making snap decisions whenever the price hits the pre-set thresholds.

  • Pullback Trading

Pullback strategy involves timing the market and waiting for an established trend to start moving in the opposite direction. For instance, an investor can wait for a general downward trend to demonstrate an upward trend and then open a short position.

  • News Trading

News and events of an asset, stock, and cryptocurrency can affect the prices in the market. Generally, the good news about an asset tends to have a positive impact on the prices. On the other hand, the bad news about a company or a change in leadership can lead to a dip in prices. However, sometimes the market can react illogically to news, so it is never full proof.

  • Momentum Trading

Momentum generally refers to the speed at which the price of a security is changing. It factors in both the price and volume information. This strategy seeks to capitalize on security as the price is gathering steam. However, because momentum trading requires following others, it doesn’t guarantee success.

Final Thoughts

Buying the dip as a strategy involves trying to predict future market conditions. If you can time the market at just the right moment, you stand to make a fortune. Unfortunately, timing the market can be challenging. Hopefully, this article helps you to successfully buy the dip.