Buying the dips refers to purchasing an asset after a correction in prices. Usually, a correction of ~10-15% is considered to be healthy. Buying on such dips helps an investor acquire an asset at a lower price. Thereby, more units can be accumulated at the same cost.
For example, a stock has a price of Rs 100. With an investment amount of Rs 20,000, the investor can purchase 200 units of the same. Now, if the price drops to Rs 90, then the investor can buy 222 units with the same amount. A similar rule applies in other asset classes like mutual funds, currency, or precious metals like gold or silver.
Buy on dips is a widely applied strategy while investing in stocks. Hence, investors should understand its strength and weakness and how to use the strategy judiciously.
The pros
Buy the dips is a term that can be repeatedly heard in the stock market. As a stock price declines in the short term, some traders and investors view this as an advantage. They use such corrections to enter in a new stock or add to an existing position. It brings the overall cost of security down and helps in averaging the losses.
For example, an investor buys 20 units of stock X at Rs 200. The investor buys another 20 units when the stock price drops to Rs 150.
Here, his buying price will average out to Rs 175 from Rs 200 and his loss on the holding will reduce from 25% to 12.5%
When you add more units of stocks during a market dip, you are not speculating the market’s direction. Instead, you’re reacting to what the market has already done. It helps you in price discovery by investing new money at an attractive price point.
And the cons:
Like any other market strategy, even this strategy doesn’t come with a guarantee. Buying on dips is often a tricky decision. An investor needs to know the reason behind the correction to make a buying decision.
Asset prices can drop for many reasons and based on that the length of the holding period may vary. If the correction is a part of an overall market trend, it makes sense to buy on dips. However, if an asset price is declining due to the fundamental weakness of a company, buying on dips will work against the investor.
It is also important to judge how deep a correction can go and place the bets accordingly. If an investor buys on a 10% dip and the stock goes on to correct 30-40%, it nullifies the impact of averaging. It is a common occurrence in the stock market. Investors often get trapped in stock as they rush in to buy on dips without understanding the underlying weaknesses.
When does it work best?
The suitability of this strategy depends on individuals and their style of investment. For a short-term or positional trader, buy on dips usually gives the best result when a stock is in an uptrend. As long as the stock is making higher highs-higher lows, these pullbacks offer good investment opportunities.
But, it can be a tricky situation though when a stock is in a downtrend and making lower highs – lower lows. Here, it is a difficult task to predict the bottom. Buying the dips will not be suitable for investors with a short-term view.
However, it does throw up an opportunity to buy a stock at rock bottom valuations. A long-term investor can effectively utilize every major dip for buying into a fundamentally strong company that is in the downtrend due to the general market trend or sector-specific headwinds.
This is exactly what Teji Mandi investors should evaluate seriously – they should view every “Mandi” or fall as an opportunity to invest more. Our portfolio is designed from a longer-term perspective, and each stock would ideally be available at cheaper valuations after a correction. Starting soon, we’ll be adding a feature that nudges investors in the morning after a market fall, to invest more. Watch out for this nudge in an upcoming update!
