If you are a novice in stock markets, you may be receiving a lot of quick advice to navigate your way and earn good returns. One of the more commonly received pieces of advice is ‘buy the dip.’ Now, what exactly does this mean? Or what actually is the context for ‘dips’ in the stock markets.
Read further to find out!
What does buying the dip mean?
Stock markets are an interesting phenomenon. No stock can just have one-way movement; they run in cycles of upward and downward trends. Moreover, stocks never function individually. Their price movement is affected by several factors ranging right from international events, happenings, and policies to national events and even local elections!
Now, when stocks undergo a downside correction or dips, for any of the reasons mentioned above or more, it could be a good strategy to buy some stake in them. This buying of stocks when the market price drops is referred to as ‘buying the dip.’ In short, this helps you invest in a stock at a lower price, thereby allowing you to gain higher returns when their prices rise.
‘Buying the dip’ is a strategy wherein investors try to time the movement of a stock and invest when the price falls to lock in the best price. It can be called similar to another phrase used in the investing world – ‘Buy low, sell high’.
Wondering if ‘buy the dip’ could be employed for cyclical stocks? Read our article ‘Cyclical stocks: Things to remember when studying them ’on the Teji Mandi website.
How does this strategy work?
Buying the dip in stock markets is a simple strategy. If you read a stock or market scenario closely and observe that a particular stock may react negatively in a said situation, you can strategize to invest in that stock, assuming that the price will rise in the future. Catching a stock right during its fall and observing its potential to rise back can help you earn considerable returns.
Let’s understand this with a few real-time examples.
When Covid-19 hit the markets in 2020 March, Sensex and Nifty dropped several points. Most stocks ended trading much lower than their intrinsic value. Now, as an investor, one would need to understand that an uncontrollable factor caused this ‘dip’. If you consider buying in such a scenario, then you would be employing the ‘buy the dip’ strategy.
Let us take another example. Assume that India had a dry monsoon season. Naturally, all stocks in the agricultural sector may perform subpar. Now, you, as an investor, understand that this is a one-time event and want to take advantage of the low prices. If you buy in such a scenario, you employ the ‘buy the dip’ strategy. Here, you understand that once things are back to normal, the prices of the stocks will start rising, making you good profits.
Is buying the dip in stock markets risky?
The answer to this question is yes. Buying the dips in stock markets can be a risky strategy.
It is nearly impossible to time the markets. If the market is bearish, no matter what fundamentals the stocks have, they might be failing. Quality stocks may ride over the bear wave, but others may not. Stocks may also swing downward due to bad quarterly results, sudden policies changes, and other similar reasons. And if you invest in such stocks without ample research and understanding, you may lose considerable corpus.
Buying the dip may be successful if you can read the stock, market mood, and technical correctly and holistically. The strategy’s success depends on one crucial thing – the reason behind a stock’s downward movement. Is the stock falling because of a generally downward trend in the stock markets, or is it particular to one stock? The implication here is a stock may not necessarily always fall due to external or uncontrollable factors.
The most significant risk of this strategy is that the stock may continue falling after you have taken a position. In such a situation, your losses may be potentially huge. Also, stock selection is the backbone of this strategy. If you opt for sub-par stocks, this strategy may backfire. A prime example here can be the Yes Bank share. Considered a quality share once, the stock today is no more than a penny stock. Had one bought this stock during its ‘dip,’ they would have lost all capital today.
The ‘buy the dip’ strategy is best employed with quality stocks. No matter the situation, such stocks always help build strong portfolios. Even if these stocks fall momentarily, they represent good buying opportunities. And buying them could be a game-changer because you will get quality stocks at cheaper prices.
How to deploy the ‘buy the dip’ strategy?
Before employing this strategy, one needs to understand that it is not the same as buying undervalued stocks/penny stocks. Market conditions may push sub-par stocks further below, hurting your capital. Buying the dip can be profitable if applied to quality stocks with the right timing. Let us take a look at the graph of SBI (State Bank of India) below to understand this more clearly.
SBI is perceived to be a quality stock by a majority of the investors. Besides that, the stock is fundamentally strong and has given good returns over the years to investors. And yet, the stock, as observed over the past years, has been highly volatile. This volatility can be extremely helpful in employing the ‘buy the dip’ strategy.
Every time the stock fell, it presented investors with a good buying opportunity. If you invested in this stock during its trough in 2017 and 2020, you would have collected massive profits. Also, note how the stock movement, in the long run, has been upwards only.
It is always suitable to view this strategy from a long-term perspective. Short crests and troughs cannot make you huge profits. Instead, buying the dip and holding may prove to be a better strategy, also one that safely mitigates risk.
Conclusion
As an investor, you can employ several strategies to gain profits. One of the more common strategies is buying the dips in the markets. This strategy allows you to buy stocks that are falling in value with the aim of generating profits when they move upside. This strategy needs a deeper understanding of the stock and market movements. It is also critical to understand the reasons behind a stock’s price fall. Consult your advisor before buying a stock or related schemes.
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