What Is Buy the Dips?
Let me explain what 'buy the dips' really means. It's when you purchase an asset after its price has dropped, believing that this lower price is a bargain because the dip is just a temporary setback, and the asset will likely recover and rise in value over time.
Understanding Buy the Dips
You've probably heard the phrase 'buy the dips' after an asset's price falls in the short term. As a trader or investor, you might see this as a prime opportunity to buy or add to your position. This idea stems from price wave theory, where buying at a lower price positions you for gains if the market bounces back.
The strategy varies by context and success odds. If you're saying you're buying the dips in a long-term uptrend, you're hoping the uptrend continues after the drop. In cases without a clear uptrend, you might buy expecting one to develop soon, aiming to profit from a future rise.
If you're already holding a position and buy more during dips, that's averaging down—you're getting additional shares at a lower price, which reduces your overall average cost. But if the price doesn't recover, you're just adding to a losing trade.
Limitations of Buy the Dips
Remember, like any trading strategy, buying the dips doesn't guarantee profits. Assets drop for various reasons, including shifts in their fundamental value, so a cheaper price doesn't always mean a good deal.
The challenge for most investors is telling a temporary dip from a signal of deeper declines. While there might be hidden value, buying more just to lower your average cost isn't always smart—it could expose more of your portfolio to risk. Some see averaging down as a path to wealth, others as a sure way to lose money.
Take a stock dropping from $10 to $8: it could be a buy, or it might not, due to issues like poor earnings, bad growth outlook, management changes, economic woes, or lost contracts. It could keep falling, even to zero in the worst cases.
Important Note on BTFD
There's also BTFD, or 'buy the f****** dip,' which is a more aggressive take on dip-buying, often pushed by traders in volatile markets like Bitcoin.
Managing Risk When Buying the Dip
Every trading approach needs risk controls, and buying the dip is no exception. When you buy after a fall, set a risk limit, like deciding to sell if the price hits a certain low point. For instance, if a stock drops from $10 to $8 and you buy, you might exit at $7 to cap losses if you're wrong and it keeps declining.
This works better with assets in uptrends, where dips are normal pullbacks. As long as prices make higher lows and highs, the uptrend holds. But once lower lows appear, it's a downtrend, and buying dips there means cheaper prices that keep getting cheaper—most traders avoid that. Long-term investors might still see value in downtrend dips, though.
An Example of Buying the Dip
Look at the 2007-08 financial crisis: stocks like Bear Stearns and New Century Mortgage crashed hard. If you followed buy the dips, you'd have bought more as prices fell, expecting a return to previous levels. But that didn't happen—these companies collapsed, with New Century's shares dropping below a dollar after trading at $55, and trading even got suspended.
On the flip side, Apple's shares from 2009 to 2020 rose from about $3 to over $120, adjusted for splits. Buying dips in that period would have paid off significantly.
Key Takeaways
- Buying the dips means going long on an asset after a short-term price decline, often repeatedly.
- It can be profitable in long-term uptrends but tougher or unprofitable in downtrends.
- Dip buying lowers your average cost for a position, but always weigh the risks and rewards.
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