“Buy the dips” means purchasing an asset after it has dropped in price. The belief here is that the new lower price represents a bargain as the “dip” is only a short-term blip and the asset, with time, is likely to bounce back and increase in value.
Understanding Buy the Dips
“Buy the dips” is a common phrase investors and traders hear after an asset has declined in price in the short term. After an asset’s price drops from a higher level, some traders and investors view this as an advantageous time to buy or add to an existing position. The concept of buying dips is based on the theory of price waves. When an investor buys an asset after a drop, they are buying at a lower price, hoping to profit if the market rebounds.
Buying the dips has several contexts and different odds of working out profitably, depending on the situation. Some traders say they are “buying the dips” if an asset drops within an otherwise long-term uptrend. They hope the uptrend will resume after the drop.
Others use the phrase when no secular uptrend is present, but they believe an uptrend may occur in the future. Therefore, they are buying when the price drops to profit from some potential future price rise.
If an investor is already long and buys on the dips, they are said to be averaging down, an investing strategy that involves purchasing additional shares after the price has dropped further, resulting in a lower net average price. If, however, dip-buying does not later see an upturn, it is said to be adding to a loser.
Limitations of Buy the Dips
Like all trading strategies, buying the dips does not guarantee profits. An asset can drop for many reasons, including changes to its underlying value. Just because the price is cheaper than before doesn’t necessarily mean the asset represents good value.
The problem is that the average investor has very little ability to distinguish between a temporary drop in price and a warning signal that prices are about to go much lower. While there may be unrecognized intrinsic value, buying additional shares simply to lower an average cost of ownership may not be a good reason to increase the percentage of the investor’s portfolio exposed to the price action of that one stock. Proponents of the technique view averaging down as a cost-effective approach to wealth accumulation; opponents view it as a recipe for disaster.
A stock that falls from $10 to $8 might be a good buying opportunity, and it might not be. There could be good reasons why the stock dropped, such as a change in earnings, dismal growth prospects, a change in management, poor economic conditions, loss of a contract, and so forth. It may continue to drop—to $0 if the situation is bad enough.
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