Why Buying The Dip Is Not A Great Strategy
During the Covid-19 induced market crash many new investors got into investing during time which coincided with one of the fastest and steepest bounce back in the market that we have ever seen. Any stock that you bought in 2020 made you money and most of 2021 any pull back was a buying opportunity as there were not alternatives to stocks. Now that market dynamic has shifted with many young investors who bought every dip this year have gotten burnt. Some of the stories I have come across from friends, emails and social media has been heart shattering. As many young investors had never lived through a bear market and are now slowly realizing that every dip is not a buying opportunity as the market kept going lower.
Let’s take Zoom (Ticker: ZM) it is down almost 80% from its $559 All time high, similarly ARKK ETF (Ticker:ARKK) is down from its all time high. Many investors bought into the story and the future that these companies were selling rather than the odds of them growing into their valuation multiples. If you bought every dip on some these stay at home names you would have quickly found yourself underwater on your investment. Now you might be wondering how can I know when to buy the dip or when has the stock bottomed?
The straight forward answer is that this is not always easy to tell. You need to look at the macro environment, political environment and the monetary policy in addition to wether it is a bull or bear market and what stage of the business cycle. In the bull market of 2020 every dip was a buying opportunity. Now as the monetary policy is tightening and growth is slowing valuation becomes crucial. When I look at buying the dip I look for the following for signs of a reversal before I consider entering a trade.
Take a look a the Meta (Ticker:FB) chart from the past 2 weeks. It looked like it was in a clear downtrend making lower sets of highs and continuing to trend down in the downward channel. Over the last few days it broke out of this trend. This would be a green candle above the blue trend line to confirm a reversal. I usually wait for 1 or 2 more green candles to confirm that the downward trend has been broken. As you can see below the 3rd green candle is higher than previous sets of high. To me this was indicative that at least for the short term this was a sign of a reversal and I took a small position in to trade the breakout. I want to point out just because it has broken out of the trend line it does not mean that it would go back to all time high. This is why stop losses and position sizing is important for risk management. As over the next few days you will see FB test the overhead resistance at $240 as that’s when sellers would step in. As many investors might have seen FB at sub $300 and bough into it will be looking to offload their shares.
The main take away of this post is buying the dip only works in the early stages of a bull market and most importantly risk management is essential that you do not end up buying every dip and losing your life’s savings. As always feel free to reach out if you want to chat in greater detail about any topic.
