Buying the dip is used by investors who purchase shares of an asset when the price is dropping, assuming that it will recover back up, hence the word dip.
“Buy the dip” is a phrase used on a daily basis by investors and traders worldwide. Buy the dip is said after an asset’s stock price has fallen and it simply indicates buy now that the price has “dipped”. Naming it “the dip” indicates a short time dip and the asset will most likely bounce back and rise in value. This is a great strategy to use when you are stepping into a bearish market because most people will panic and sell their shares at a loss. Bearish or red days should be treated with this strategy because it gives traders the chance to buy their “favorite” stocks at a “discount”.
“Buying the dip” after an asset price has dropped is for many investors and traders heaven to purchase shares or add additional shares to their existing position. Overall, “buy the dip” is based on the theory of price waves. The investor is buying the stock at a lower price in order to potentially benefit from the price going back up.
Buying the dip can be used for different odds of working out profitability such as dropping more than 15% in a day or dropping more than 15% compared to last month. Long-term investors could even compare dips to quarters. Other traders use this phase when the stock is dipping on an average uptrend therefore, they believe this uptrend will continue. On the other hand, people tend to buy dips even if there is not a clear uptrend.
Buying dips can many times “save” in a way investors and traders that were stuck on stock for quite some time in order to average down their entry price and sell the stock without carrying any losses. This can remind you of the Dollar Cost Averaging method.
The strategy, buying the dip, does not guarantee any profits just like every other strategy there is always risk involved. An asset might drop for several reasons. Bad earnings, something wrong with the products, changes in the value, or due to the overall behavior of the market. For example, when one specific sector is getting hit is usually due to fears about interest rates or new regulations that could impact that specific sector.
However, the main problem with the average investor is that people do not know how to distinguish a temporary drop in price and a warning signal that the price will continue to go lower. Even if averaging down is a good method to average down, it doesn’t mean that exposing yourself to a greater percentage of that stock is always good. This is because it always depends on the company that is behind the stock. Is it worth it to expose yourself more? Will this result in a greater loss? These questions should definitely be asked before you make any move.
Consider the COVID-19 pandemic that hit the globe hard and especially reflected the financial market in March 2020. Technology companies, commodities, cryptos, indices, stocks, currencies, everything was down! An investor who routinely practiced a “buy the dip” philosophy would have grabbed all these assets at humiliating prices, given that the world will sooner or later recover from this deadly disease. Imagine trading Groupon (GRPN) at $7 in March 2020, the stock is now back to $39. And this is only one of the many examples. In March 2020, the price of oil had dropped to levels not seen since 2002 as the demand for crude oil collapsed. In April 2020, US crude oil fell to negative for the first time in history after oil producers ran out of space to store the oversupply of crude left the coronavirus. Do you understand what this means? The price dropped from $18 per barrel to -$38 in a matter of hours!