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How to buy the dip in Stocks
Buy the dip and sell the rip
Buy the dip and sell the rip. This is one maxim that’s popular among stock day traders. While buying the dip seems like a walk in the park, it’s not always easy to execute such trading strategies in the stock market.
To make the most of this trading strategy (speaking of buying the dip), one must make time to understand what it entails to “buy the dip” and grasp how to buy the dip in stocks.
What does it mean to buy the dip?
The idea behind this trading strategy follows the basic investment principle of buying low and selling high. However, with stocks, it’s not a knee-jerk decision. Instead, it requires a targeted approach.
To buy the dip in stock, the instrument must meet certain conditions. First, there has to be a sharp decline in stock price, and secondly, there must be an indication that the price will rise again. An example of such a situation is when the stocks of a large corporation drop due to market fears and not because of the company’s long-term performance.
Here is a more relatable example to help you paint a picture of how buying the dip in stocks works. Prior to the Covid-19 market crash in 2020, Johnson and Johnson’s stocks were at an all-time high on February 5. Fast forward to March 23, the company’s stocks were down by at least 28%.
However, come April 20, 2020, the company’s stock regained momentum and erased all losses. In this example, if you had bought Johnson and Johnson’s stocks in late March of 2020, you would have bought the dip.
While buying the dip may seem all rosy and juicy, it comes with its inherent risks. For example, the fact that the price of a particular stock is pulling back doesn’t mean it is an automatic buy. One has to consider other factors before determining whether it is safe to buy or not. On this note, we should also add that no trading strategy is 100% full-proof. As such, your strategy can not be spot on every time.
Since no one knows when a particular stock will hit bottom, it is almost impossible to the market. So the best you can do is to take positions that offer the best investment opportunities and also has the highest ROI potential.
Top tips on how to buy the dip in stocks
Rack that buying the dip in stocks means purchasing an asset at a temporary lower price with the hope that it will rebound and increase in value.
To increase your chances of spotting a dip opportunity in the market and rake in decent profits, there are factors you should add to your checklist. Let’s take a look at some of them.
1. Look at sectors that are hit hardest during the sell-off
If you are familiar with the stock market, it is common knowledge that the market index funds track a wide range of stock market indexes such as the S&P 500, and they present profitable investment opportunities.
The broad market index funds can also be applied to the 11 sectors that make up an index. This means that you can conveniently look at sectors with the largest share price decline and analyze the mutual funds or exchange-traded funds (ETF) that tracks the sector you have in mind and gives you pointer opportunities to buy the dip.
To give you a head start, here are four stock market sectors that saw the largest year-to-date decline courtesy of the COVID-19 crash in April 2020.
The S&P is energy was down by at least 45% with the energy equipment and services industry taking the biggest hit at 61% losses.
The financial sector was also not spared from the COVID-19 market crash. It dropped by more than 28%. This severe drop was primarily driven decline in banks and consumer finance, which were down 39% and 43%, respectively.
The industrial sector, which comprises industries like construction and engineering, defense, aerospace, airlines, and electrical equipment also suffered a severe decline. The entire sector went down 24% with the airline industry slipping nearly 57%.
The materials sector was down 20% and it comprises industries like metals and mining, chemicals, containers and packaging.
2. Take closer look at large companies with big drops
Like Johnson and Johnson, a good number of the country’s largest companies have already erased their losses and are on a growth trajectory after the COVID-19 downturn. Companies like Microsoft and Amazon have been able to recover with both companies’ stock prices up year-to-date. So, for these companies, the opportunity for buying the dip is over for now.
However, some blue-chip companies are yet to recover from the impact of the global pandemic. Looking for opportunities to buy dips in these companies presents investors with the opportunity to buy into large corporations at the lowest prices.
While you are at it, you should bear in mind that low-cost index funds carry lees risks compared to individual stocks, and they offer diversification to your portfolio through a single investment.
3. Max out your 401(k)
Another option available to investors during market dips is buying additional shares of investments you already own — but this time, you will be buying them at a lower price.
However, you should only consider upping your contributions if you have a reliable source of income and emergency funds to tide you over until the stocks regain steam.
Last but not least, you can also use dollar-cost averaging. This involves making steady investments at regular intervals rather than making a one-time lump-sum contribution.
With dollar-cost averaging, you will continue to buy/purchase an asset throughout the dip. The idea is to invest a percentage of every paycheck at a regular interval over a long term.
Like every other type of investment, you should have a risk-control and plan before buying the dip in stocks. You should also learn to limit your loss if your analysis is wrong and the stock price keeps dropping.
Buying the dip in stocks works best with assets that are in an uptrend. That way, you get to buy the dip or pullbacks as the trend makes higher lows. The formation of lower highs is usually an indication that the asset is in a downtrend, and you should consider closing your positions or cutting your loss. The last thing you want to do is hold on to a losing asset or buy stocks in a downtrend.
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