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What is the Buy On the Dip Investment Strategy? Is it the Way to Go as the Stock Market Awaits Another Correction?

Aug 7, 2020 1:51 PM 3 min read
Editorial

The domestic stock markets in India witnessed a mild correction in week ending July 31st 2020, potentially driven by the rising numbers of COVID-19 cases and RBI’s warning of rise in bad loans to 12.5% of total advances by March 2021 - highest since 1999.

Benchmark indices like the Nifty 50 closed at 11,073, down by 120 points and the Sensex weakened by 421 points to 37,607.

On the global front, Morgan Stanley analysts recently opined that stocks will fall 10% before a "surprising recovery" later in the year and into 2021, pushing markets back up. 

Fast Fact: For the uninitiated, in investing, a “correction” is a decline of 10% or more in the price of a security such as individual stocks, currency markets, indices and any asset which can be traded on an exchange, from its most recent peak.

Against this anticipation of a "second wave" of coronavirus-driven market correction, has risen the debate around the “buy the dip” strategy. 

While some outrightly dismiss it and prefer sitting out during a downtrend, others swear by this investment strategy. Today, we dive in.

 

What is Buy On The Dips Strategy?

Buying the dips refers to purchasing an asset after it has declined in price, with the expectation that it will rebound or show an uptrend in the future (near or long-term). The technique is used to acquire a new asset or even to average out on the existing portfolio.

 

To Buy On the Dip or Not?

Honestly, the numbers are tempting. 

Research by asset management company Schroders has found that over the last 30 years, the US stock market returned an average of 25% in the 12 months after drops.

As per a S&P report, “a strategy of investing in securities that fell more than 10% relative to the broader market index, during a single day, significantly outperforms the index between 2002 and 2017 in the subsequent periods.” 

In fact, Jonathan Clements, a British author (and scriptwriter) credits Buy the Dip as a huge contributor to his financial success:

...when you invest more in stocks during a market dip, you aren’t guessing the market’s direction. Instead, you’re reacting to what the market has already done. In that sense, it’s similar to rebalancing. When you rebalance, your goal is to bring your portfolio back into line with your target asset allocation. When you buy the dip, you’re helping that goal along - and, if it means you’re adding new savings to your overall portfolio, that’s all the better.

 

What is really needed is a certain temperament, along with years of investment experience, to ignore the crowd and the prophets of doom, as per him. 

Having said that, we have seen plenty of examples where the strategy has led to financial disasters, such as in case of the tech stocks in 2000 or real estate and infrastructure stocks in 2008. Countries such as Italy and Japan have seen much longer weak periods than the US. Many are still trying to recover from their losses. 

And therefore, beforing buying a dip, an investor must closely examine why the stock is falling? Is there a change in the fundamentals i.e. Lower earnings, poorer growth prospects, or change in management? In those cases, a lower price doesn’t necessarily guarantee higher value.

However, buying dips in stocks with high institutional ownership, strong price trends, and stable fundamentals can be a high performance strategy. 

FIN.

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