How To Buy the Dip: 3 Tips and Strategies For Success
Investors experiencing a bear market, when prices are trending down, face a choice with their investments: holding, selling or “buying the dip.”
Stock Market Trends
Bear markets generally aren’t selective about which stocks get hit with a price decline. Good and bad companies see share values drop. The reason? Traders are going with the trend by selling, and investors are bailing out due to pessimism and the fear of losing even more money than they already have.
If your stocks are down with the rest, what you have until you sell are paper losses. And there’s hope in an important principle of financial history. Stock markets eventually recover from these declines and always trend up over time. The time frame for a recovery may be two months or two years — the date of the market “bottom” can’t be known until it has already occurred.
Eventually, however, confidence returns, and investors decide they’re willing to again put their money at risk. They stop selling and start buying, and as they do so, prices stabilize, then begin to rise.
3 Ways To Buy the Dip
The goal with jumping back in and buying the dip is to buy smart as well as cheap. There are useful strategies to follow, and once the skill is mastered, a confident investor can profit from anticipating the bull market to come.
1. Don’t Buy on Impulse
Bear markets, by one common definition, occur when a stock index like the S&P 500 falls from a recent peak by 20% or more. Individual stocks, of course, can fall more than that. One example of a bear market would be the first half of 2022, when high-flying growth stocks such as Cisco and Salesforce lost more than 30% of their value.
For experienced market watchers, big price declines look like a clearance sale. Before diving into the stock market bargain bin to try to buy the dip, though, it’s wise to evaluate your own financial situation.
- Is this a good time to be risking money?
- Do you really want to defy the downward trend and try to outguess the market?
- Would your cash be better deployed paying down debt or used to strengthen an emergency fund?
Instead of volatile growth stocks, how about placing newly available capital in more conservative investments such as savings bonds, which are backed by the U.S. government and require only a $25 minimum investment? In addition, bank savings and money market accounts have kicked up their yields, which now approach 2% at some banks.
The price that might look like a too-cheap bargain may be an honest value, given the state of the economy and the prospects for the company’s future growth. If “the trend is your friend,” as old market hands often say, then the smart play may be waiting for the trend to reverse.
That means patiently waiting for a series of higher lows on the stock price and the market holding steady even when bad news hits. These are signals that investor confidence is starting to return.
2. Do the Research
Not buying on impulse implies doing careful research on investable companies. This means reading through the latest quarterly and annual earnings reports, checking balance sheets and income statements, and considering the stock’s historic price-to-earnings ratio.
Any stock will have a P/E range, with the high indicating a period of maximum investor optimism and the low showing how cheap the shares get when the company is out of favor. Following this indicator is one good way to evaluate the stock. Is the P/E falling with the rest of the market or because the company is making better earnings and not being recognized for it?
If the share price has fallen because of poor earnings, a big debt load or a changed business outlook, then buying low may result in selling even lower as the stock continues to slide. Your evaluation of a company should always take the health of the business into account, no matter the general market conditions.
This is where a close read of the financial media comes in handy, as well as a browse through those wordy corporate reports, most of which are available online. Favor companies with:
- Positive and increasing cash flow
- Earnings growth
- Low debt
- Good management
- Favorable business trends
Avoid the flavor of the month or week: companies that are trendy but unprofitable. Also watch for those that might be negatively affected by larger economic events, such as a shift in consumer sentiment or strengthening competition.
3. Think Long-Term
Traders attempt to time market swings, while investors take a long-term view. They realize that prices fluctuate daily, with down and up days constantly alternating. When this aspect of the market is understood, it’s easy to ignore the short-term swings and just stay with a good company no matter what the price does.
Chances are strong that a good investment will eventually gain more buyers, as long-term investors hold on to their shares and the price rises to much-improved levels.
Generally speaking, buy-and-holders make out better than day traders, who jump in and out of stocks as prices swing up and down. Investments held for more than a year incur lower tax rates when they’re sold, and brokerage fees can affect results when one trades frequently.
Buy-and-hold requires patience, however, as well as the ability to ride out price drops without worry. If you’re feeling a bit unnerved by market volatility, it might be wise to move out of individual stocks and into diversified investments such as stock mutual funds or index funds, which smooth the bumps by investing in a large group of individual companies.
Bear markets can be discouraging for the most optimistic and steadfast investors. With experience, however, these same discouraged investors begin to see a bear market as an opportunity.
The key is to devise a plan suited to your own investing approach and to stick with it. With time, you’ll recognize a declining market as an ordinary feature of the financial landscape, and this view will drop the fear level considerably.
- What does the expression "buy the dip" mean?
- The expression refers to buying stocks when their prices are trending down in an attempt to profit when prices start rising again.
- Is "buy the dip" a good strategy?
- This is a good strategy only if done after careful research on the company to ensure its business is still viable and profitable.
- What's the opposite of buying the dip?
- The opposite strategy is known as "Selling the rip," or unloading stocks when their prices rise too far, too fast.
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