A common piece of advice for cryptocurrency investors in Kenya is to try to ‘buy the dips.’ But if you’re new to bitcoin investing or unfamiliar with the lingo, you might not know what that means. In short, buying the dips means trying to buy a cryptocurrency, when the market price drops. This lets you get stocks at a lower price, which can help you make more money from your investments.

Buying the dip is a form of market timing where you try to predict how the market will move in the future, and then make buying and selling decisions based on your predictions. This contrasts with buy-and-hold investing, where you buy investments and hold them for the long term, relying on long-term gains to grow your portfolio.

Timing the market can be difficult, risky, and doesn’t work for most investors—even professional money managers—but those who succeed can make a lot of money.

What Is ‘Buying the Dips’?

Buying the dip means trying to time your investment purchases so that you buy stocks when they have dropped in price, assuming they will continue to rise in value.

If you look at a stock chart, especially one that looks at a long period of time, it may look like the lines that move up or down are relatively flat. In reality, stock prices are volatile and those flat lines include peaks and dips. If you can buy stocks that have an upward price trajectory right after a temporary dip in price, you can earn a greater profit than if you bought them at one of their peaks.

In hindsight, one example of a company where investors could buy the dip in 2020 was 3M, a conglomerate company that owns well-known brands like Ace and Scotch. At the start of March 2020, the company’s stock price closed at $153.02. As the ongoing public health crisis worsened, its price dipped to $124.89 on March 20. Throughout the year as the market recovered, its price began to rise again, but continued to have occasional dips that offered investors looking to buy the dip an opportunity to purchase shares.

Each dip a stock experiences gives investors an opportunity to purchase shares at a low price, increasing their potential profits.

For example, the stock spent most of April hovering around $145 per share, then dropped to $138.69 in mid-May, before rising to $167.41 at the start of June. This pattern continued many times, and as of March 15, 2021 the stock was priced at $189.48.1 

Does Buying the Dips Work?

Buying the dips relies on being able to predict how a stock’s price will change in the future. If you’re confident that a stock will continue to gain value overall, buying shares just after a price drop can mean you’re getting a good deal. However, if you’re wrong and the stock continues to lose value, you’ve just bought shares near a high, meaning they could have a long way to fall.

Making investing decisions this way—trying to buy low and sell high, rather than buying and holding for the long term—is risky. If you succeed, you can make a lot of money, but market timing is highly difficult and could also result in you losing money. Timing the market also tends to incur more fees than long-term investing, so the additional return you earn from your active trading should be enough to offset those fees for it to be worth it.2 

Buying the dip is often encouraged by traders in hot sectors or stocks and can be popular during bull markets—when the market’s upward trajectory is temporarily punctuated with pullback in stock prices.

How to Buy the Dips and Manage Risk

Buying the dips can be risky, said Walter Russell, President and CEO of Russell and Associates. “For long-term investors, we generally recommend dollar-cost averaging. A good example of this is that in your 401(k) plan, you make regular contributions. With dollar-cost averaging, you naturally buy during dips.”

Russell noted that if you try to buy the dips and prices continue to drop, you might not see gains on the investments for years, making it a riskier decision for investors. 

But there are ways to succeed, according to Andrew Wang, managing partner at Runnymede Capital Management.

“When buying the dip on individual stocks, it is important to identify the reason for the dip,” explained Wang in an email to The Balance. “Is a stock down because of a broader down move in the overall market, or is it unique to the company? Further, when buying the dip, it is important to focus on stocks that have positive fundamentals and good value. The biggest risk of buying the dip is entering a stock that will continue to go down further. You want to avoid the worst-case scenario of trying to buy the dip of a company that’s on its way to bankruptcy.”

Buying the Dips vs. Dollar-Cost Averaging

An alternative to active investing strategies like trying to buy the dip is dollar-cost averaging—a common strategy for long-term investors that takes the emotion out of investing. 

With a dollar-cost averaging strategy, you make regular, equally-sized investments in the market, regardless of the price or how it fluctuates. For example, you may decide that you want to invest $100 every single month.

The idea behind dollar-cost averaging is that over time, you’ll sometimes buy at market highs and sometimes buy at market lows. However, if you invest the same amount of money every time, you’ll buy fewer shares when prices are high and more shares when prices are low. That means that you’ll naturally wind up owning more shares that were purchased at a good price.

Dollar-cost averaging is a much easier strategy compared to timing the market because you don’t have to constantly monitor stock prices. All you have to do is decide how much to invest and how frequently you want to buy shares.

Many brokerages will even let you set up recurring transactions, making the investing process almost completely automatic.

The Bottom Line

Buying the dip is an investment strategy that relies on predicting future price movement. If you can time the market—buying shares at a low price just before they gain value—you can earn a tidy profit. However, timing the market can be difficult and you’re just as likely to buy shares that continue to fall rather than shares experiencing a temporary dip in price.

If you’re confident in your abilities as an investor, trying to buy the dip can be worth the effort, but a simpler, more long-term strategy like dollar-cost averaging is likely to be better for most investors.

Source: TheBalance

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