Whether you are a beginner to investing or a pro, you have probably heard people telling you to “buy the dip.” But, what exactly does buying the dip mean, and how or when do you do this?
These are all valid questions on our minds when we start putting our money on the line. As users of the buy the dips strategy ourselves, we will cover some guidelines of ways to buy the dip and things to keep in mind to use this strategy successfully.
- Buying the dip refers to purchasing financial securities after their prices drop in value.
- Five strategies to buy the dip include (1) identifying trends, (2) using technical indicators, (3) dollar-cost averaging, (4) creating a plan, and (5) doing your homework.
- Some tips and tricks to keep in mind are starting small, staying patient, and managing your risk.
What Does Buying the Dip Mean?
Buy the dip refers to purchasing a financial asset, such as stocks, commodities, or cryptocurrencies, after its price suddenly drops. For example, Tesla shares fell from $900 in February 2021 to $539 in March 2021 after months of running up – a roughly 40% drop. Investors who were closely watching Tesla during this period may have seen this dip as an opportunity to jump into the stock or add shares to an existing position.
By purchasing the asset at its low, you benefit when its price recovers. However, in doing so, you assume that the “dip” is only temporary, and the asset will rebound and rise in value over time (which is not always the case).
Buying the dip is a strategy that follows the “buy low, sell high” principle, where investors and traders wait for the right opportunity to buy a security to maximize profits. The main difference is that this strategy takes a more targeted approach and focuses on assets that are more likely to rise after a sharp price decline. An example is when Apple’s share price suddenly drops due to external reasons, but nothing has fundamentally changed internally.
While more experienced traders and investors will look for windows of opportunities to use this strategy, nobody knows when the bottom will hit. We generally do not recommend timing the market because you could miss out on great opportunities while waiting on the sidelines. Instead, focus on finding opportunities where assets on your watchlist experience a down period.
Note that buying the dips will mean something slightly different for each person depending on their investing or trading style, risk tolerance, and level of financial literacy. Make sure to do your research and set limit orders where possible to take advantage of dips.
5 Ways to Buy the Dip
1. Look for Trends
Before buying the dip, identify the market trend. That includes looking at the price action for that specific day or a few weeks or months out. By identifying the overall trend, you can better determine if the security is worth buying and avoid catching a falling knife.
For example, let’s say that shares of Nvidia have been steadily climbing the last several months. However, there is news of a slight supply chain issue caused by a third-party vendor that has delayed its graphics card production, leading its share price to fall. If Nvidia’s internal management and product roadmap remain unchanged, this may be a great time to take advantage of the dip as the company is likely still a solid investment.
Another strategy is to look at the trends for the overall industry or sector. Sometimes entire sectors, such as technology, travel, and financials, will drop in value simultaneously. Throughout 2020 and 2021 alone, there have been several rotations in and out of tech.
2. Use Technical Indicators
Technical indicators such as volume, price action, trendlines, VWAP, etc., are super helpful when deciding if an asset is worth buying during a dip. You likely will not need to use every indicator out there, but there are a few that could be helpful for your investing or trading strategy.
Trading volume allows you to determine how much momentum a security has and how volatile its price will be that day. This indicator will be more relevant for day traders and swing traders as they look for potential trading opportunities.
If you are trying to trade, make sure that the asset has enough volume to support breakouts. The greater it is, the easier it will be to move in and out of the security. If there isn’t enough volume, you could end up bagholding your position.
Looking at the price action of a security helps you determine the direction the price may be heading and momentum. Usually, when a trend gets established, the security is more likely to keep moving in that direction. We recommend trading with the market trend and following the price action to find good dip-buying opportunities.
Trendlines and Moving Averages (MAs)
Trendlines and moving averages help you identify patterns to pay attention to.
Trendlines are lines that traders and investors draw on price charts to connect different data points. The resulting lines help you identify the direction and speed of price action, as well as potential patterns. For example, if a stock’s price closely follows the trendline, that may be a solid area to trade around.
Moving averages are an indicator that summarizes past prices. To calculate MAs, take the closing prices of the asset in a specified period, such as five days, and divide by the number of periods (in this case, five). If the price is above the moving average, that is a sign of strength. If the price is below the moving average, that is a sign of weakness. If the price generally follows the MA, it’s better to buy when it dips closer to the MA if the security is trending upwards.
Note that both indicators are lagging indicators, meaning they do not always reflect what is happening in real-time. Whenever there is a conflict between the price action and market structure, go with price action.
Support and Resistance Levels
Support and resistance levels are important indicators for identifying dip opportunities as they help determine potential breakouts or downtrends. Think of these levels as hypothetical ceilings and floors for price action.
When you look at a price chart, the support level is an area with potential buying pressure or a concentration of demand. In other words, at this level, buyers are more likely to push the price back up and prevent the security from falling below it. The resistance level is an area where there is potential selling pressure or a concentration of supply. At this level, sellers are more likely to suppress the price and reverse its upward momentum.
Finding relevant support and resistance levels will help with identifying areas to enter or exit positions. Typically, securities will consolidate near these key price targets and test these zones.
A Fibonacci retracement is a popular tool used by short-term traders. It identifies clear levels of support and resistance using horizontal lines. Each level is based on Fibonacci numbers and associated with a percentage representing how much the price has pulled back, or reversed, from a prior move. The official levels are 23.6%, 38.2%, 61.8%, and 78.6%, though 50% is also commonly used.
When you see the price of a security freefall, pay close attention to these levels. If the price moves below 23.6%, the bears are in control, and the 38.2% might be next. If it continues falling, it might not be a good time to buy the dip. But, if the price bounces back up after hitting 38.2%, that may be a buying opportunity.
3. Dollar-Cost Average
Dollar-cost averaging is a strategy often employed by long-term investors to buy and hold securities for an extended period, such as years or decades. It involves buying assets regularly, regardless of whether they are at all-time highs or bottomed out.
An example of dollar-cost averaging in action is an employer-sponsored 401(k). Currently, I set 5% of all my paychecks to get automatically invested into a couple of index funds. Even if the stock market dips, I will continue investing that 5% into my 401(k).
You can use this strategy across all investment accounts, not just retirement accounts. I currently use a slight variation of this strategy in my investment portfolio. Given the volatile nature of cryptocurrencies, I usually deposit a percentage of my paycheck into my exchange, set relatively low price targets, and wait for them to hit. But, sometimes that means waiting days or weeks for the prices to dip to my targets.
When you incorporate dollar-cost averaging into the buying the dip strategy, that will not guarantee that you will buy at rock-bottom prices. Sometimes, the price will continue to fall after you take a position. If you believe in the security’s long-term value, you may have to stomach multiple drops before the price starts going back up.
4. Create a Plan
Before making any trades, make sure to have a game plan ready. Unless you can see the future or are just really talented, you probably will not see positive results by going in blind. If you plan on trading using the buy the dip strategy, make sure to decide entry and exit points, limits, risk, etc. If you plan to hold your position long-term, do some research into the security and look for indicators to determine whether it is worth buying.
One way to enter a trade is by setting a limit order for when the security falls below a certain percentage from its recent high. For example, Square shares peaked at $289.23 in August 2021 and have been trending downwards (as of this writing in September 2021). Let’s say I set a limit order to buy the dip when the price falls 15% from this high, which is roughly $245. My limit order would have executed sometime between September 10 and 14 without me needing to monitor the market.
While this example only requires a simple trigger, it allows you to take a more disciplined approach to your portfolio management decisions without letting your emotions control you. However, the downside is that you will not know when your orders will execute, if at all. If you set your targets too low, the market may continue to trend upwards and never hit your desired price points.
5. Keep Learning
As I’ve gone deeper into the rabbit hole of personal finance, I’ve come to realize that there is always more to learn. No matter how much you think you know, there is more information out there. The only way to master the buy the dip strategy is to keep doing your homework.
Study the patterns of assets you are interested in. Reflect on your mistakes and figure out how to improve your investing or trading strategies. Pay attention to the news and potential catalysts for the markets. If you want to build your wealth, you need to learn from the past and continuously build on your knowledge.
Tips and Tricks
Start Small and Scale Up
If you are a beginner, consider starting with smaller positions to keep your risk low. There is no shame in starting with $20 or $50. Whether you begin your journey with $20 or $20,000, you can still learn the same lessons. The only difference is that you have more to lose the more money your initial investment is.
The goal here is to improve your skills, stay consistent, and build confidence. The financial markets can be scary and intimidating, especially if you start investing in volatile assets like cryptocurrencies or growth stocks.
If you are new to investing or trading, it is easy to spot dips left and right and jump in and out of positions. But, doing that will likely lead to tons of losses. As Yoda once said, “Patience you must have my young padawan.”
Rather than FOMOing into positions or jumping into every opportunity you see, do your research and find the right setups for your investing or trading strategy. Once you make a plan, be sure to go through your checklist and find the right indicators. Of course, this is easier said than done, but the importance of patience cannot get emphasized enough.
Manage Your Risk
Part of being a profitable investor or trader involves preparing for best-case and worst-case scenarios. You will probably not make the right decisions every time. Sometimes you may buy the dip, and the security never recovers. That is perfectly okay.
The markets are constantly changing, and losing is part of the process. Always be ready for that by capping how much you are willing to lose for each position you take. If you overleverage yourself, you can get wiped out from a single trade.
Even for the “safest” assets, there are risks involved. We need to recognize that nothing in trading or investing is guaranteed. If you buy the dip for a stock, that will not always mean it is heading to the moon. It could always tank even further, which is why you need to have a strategy to cut your losses when things go wrong. For more info on this, read here.
For most retail investors, we have limited resources to distinguish whether a security experienced a temporary drop or whether the prices will keep falling lower. While there is value in purchasing assets at lower average costs, it could also be a recipe for disaster. Just because a stock or altcoin is cheap will not mean it is worth buying.
Your trading strategies will not always work as an asset’s price can fall for reasons out of our control. Make sure to stay proactive and keep on learning!