Buying the dip is a phrase that is commonly used in the investing world, but what does it mean, how often does it occur, and should you do it?
Sept. 11, 2021
When the market is volatile, new investors may be confused or stressed, and colloquial phrases being used can add to this. We aim to educate investors and de-mystify these phrases.
So, what does 'buying the dip mean?
Buying the dip is a term used to describe purchasing stocks after it drops in price. This drop in price or 'dip', is often an excellent time to buy or lower the cost basis on a position where the weakness in the stock is seen as temporary. Investors hope that the stock will rebound or the uptrend will continue and that they will profit from 'buying the dip'.
History as a guide
It is near to impossible to time the stock market, but by looking at historical dips, we can gain an understanding of the frequency of these dips. According to Fidelity, since 1920, the S&P 500 (NYSEARCA: VOO) has recorded a drop of 5% on average three times a year, a 10% correction every 16 months, and a 20% drop every seven years. Despite these drops, the S&P 500 has consistently hit new highs during this period.
Famed investor Peter Lynch stated that "Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves." Rather than trying to time a dip in the markets, a buy and hold strategy and a long-term mindset will eliminate stress and maximize returns.
Should I buy the dip?
If we consider times where there has been a dip either in individual stocks or the broader market, investors often feel a sense of fear and panic. However, in hindsight, this dip will look like a buying opportunity, and adding at these times should create outsized returns. Famous investor Warren Buffett stated, "Whether we're talking about socks or stocks, I like buying quality merchandise when it is marked down." However, when you are buying the dip, it is essential to know the company you are investing in and "buy what you believe in", which is one of the Six Golden Rules at MyWallSt. If the investment thesis is still intact, a dip is an opportune time to buy.
The onset of COVID-19 in 2020 caused the fastest bear market in history before a v-shaped recovery and the S&P 500 hitting new highs. This dip provided opportunities for investors to buy on the dip, with stalwarts like Disney dropping to a five-year low at $85 a share. Since then, Disney has reached record highs of $192, and those that bought the dip will have been greatly rewarded. However, a stock dropping can lure investors in the hopes of buying at a lower price, but if the business fundamentals are poor, such as declining growth or poor management, the stock could continue to drop. One example of a faltering business that investors might have invested in is J.C. Penney, at what looked like bargain prices, only for the company to go bankrupt months later.
Both history and these examples provide a valuable lesson to investors that there is no need to panic or to try and time a dip. Instead 'buying the dip' in quality businesses when it occurs can be rewarding.
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