How To Optimize Money-Making Opportunities When Buying the Dip on Cheap Stocks

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“Buying the dip” is one of those age-old Wall Street axioms that many investors now react to instinctively. If an investment falls in value, many rush in to buy more, expecting it will pay off in the end.

But while the general principle behind “buying the dip” is solid, it’s not a guaranteed money-maker. In fact, in some cases, buying the dip is the absolute wrong investment strategy.

Here’s a look at ways to maximize profit and avoid making mistakes when buying the dip on cheap stocks.

You can also read more about “sleeper stocks” that could pay big next year.

What Does “Buying the Dip” Mean?

Buying the dip simply means buying more of an investment if its price has fallen. For example, if the price of a stock falls from $100 to $50 per share, an investor buying the dip would pick up additional shares at $50.

Some have referred to this process as “buying stocks on sale,” and if the stock eventually rises in price again, the strategy can return bigger profits to investors.

Another way to buy the dip is to simply wait until a stock falls to a certain price and then pick up shares.

How Can Buying the Dip Pay Off?

If a stock recovers from a selloff, buying the dip essentially leverages an investor’s exposure.

By adding more money at lower prices, investors lower their average cost, and consequently their breakeven point. This makes it easier to turn losses into gains if a stock makes a comeback.

Imagine, for example, that an investor bought 100 shares of Tesla at $250 per share and watched it trade down to $150 over the subsequent months. By buying another 100 shares at $150, the investor would lower his or her average cost per share to $200.

If the stock returned to $250, the investor would actually make a profit of $10,000 instead of simply breaking even, as the 200 shares would be worth $50,000, and the investor would have spent just $40,000 to acquire the shares.

Investors buying the dip in a stock they don’t already own can benefit from buying a stock at a lower entry point. If a popular stock has recently run up to a high valuation, for example, an investor might want to wait until others take some profits and drive down the share price before establishing a new position.

When Is Buying the Dip a Mistake?

Not every stock that falls goes on to recover. In fact, there are countless examples of formerly popular, big-name stocks like Blockbuster that eventually kept falling in price until they went bankrupt.

Investors who were convinced that such a high-profile name would always bounce back ended up losing all of their money.

When buying the dip, investors therefore need to be careful about chasing losses. If a stock never recovers, like Blockbuster, averaging down just throws good money after bad.

Buying the dip on a major market index, like the S&P 500, has always proven to be a good bet historically, as the stock market as a whole has always recovered and gone on to make new highs.

But the case is not nearly as clear-cut with individual stocks. To avoid tanking their entire portfolio, investors need to put a process in place to analyze whether or not they should buy the dip on a specific stock.

What’s the Best Process To Avoid Making Mistakes When Buying the Dip?

Regardless of whether an investor is buying additional shares to average down or is simply initiating a new position in a stock, research is fundamental.

According to experts, investors should be asking why the stock fell in the first place: Was it due to an overall market selloff, for example, or is there something inherently wrong with the company?

This distinction can mean the difference between gains and losses for investors buying the dip.

If a company reports bad earnings and its CEO is simultaneously unloading shares, for example, this could be a sign that there are problems with the company’s fundamental business, and investors might want to step aside.

If, on the other hand, a company drops by 20% after running up 200% in the prior year, the reason for the falling price may simply be profit-taking. If a company is still posting outsized earnings gains and reporting optimistic forecasts while insiders are snapping up shares, it may be a good time to buy the dip.

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