When and How to Buy the Dip - SmartAsset

Buying the dip reflects Warren Buffet’s famed investing advice to sell when others are buying and buy when they sell. In this case, when everyone else is selling their stocks, prices will dip. You can take that as an opportunity to buy those assets while they’re undervalued. As far as general investment advice goes, this is a good approach. However, buying the dip has its limits, just like any other financial strategy. If you don’t feel confident in your ability to do it correctly, consider speaking to a financial advisor who can help manage your portfolio and buy the dip more effectively.

What Is Buying the Dip?

Buying the dip is the practice of buying a stock when prices have fallen and you have good reason to think that they’ll bounce back. Hence the term “dip,” suggesting that the fall is only temporary. The idea behind this strategy is that it lets you buy undervalued assets.

Ideally you’re looking for strong companies with a good business model or assets that otherwise have good fundamentals. This means that they’ll regain their value in the long run, letting you profit off the short-term volatility that dragged their prices down. Or to put it more simply, you’re looking to buy low and sell high.

This is generally a strong approach to investing. For many stocks, the worst time to buy is often during an era of strong growth and high prices. At best, you minimize your gains because most of the growth has already occurred. At worst, you buy in at the peak and can only look forward to losses. Neither of these outcomes are the kind you want. Buying the dip is a strategy for avoiding all of this by purchasing stocks when they’ve lost value and holding them until their prices rebound.

When Should You Buy the Dip?

Broadly speaking, the best time to buy the dip is when an asset’s price has fallen due to external factors unrelated to its fundamental value. Basically, have share prices fallen because of issues that don’t necessarily have anything to do with the underlying value of the company? If that’s the case then there’s good reason to believe that prices will bounce back once those external conditions have passed.

The two most common examples of this are:

1. Misjudged News

Often a company’s stock price will fall when investors feel like they’ve gotten bad news. The question you should ask is whether the market has reacted to news that will actually affect the company’s value, like bad leadership or a weak product launch or news that has no relationship to the underlying business, like a bad week on social media. If investors have begun to run away based on a few misplaced tweets, you may be in a position to purchase undervalued shares.

2. Systematic Risk

This is by far the most common way to buy the dip. Systematic risk refers to conditions that affect the market overall. Individual stock prices decline not because of any company’s weakness but because investors are selling in general. This can happen, for example, if a specific industry has experienced difficulties or if a bear market has hit stocks overall.

Systematic risk isn’t always a temporary condition. For example, say an entire industry depends on a resource that has grown scarce. This would pose a systematic risk for the industry as a whole, but the problem could endure. However, in most cases, systematic risk will represent a short-term drag for companies with strong underlying business models.

To buy the dip, then, you want to look for these conditions. You want to look for companies or markets that have declined based on external factors unrelated to their underlying business model. The best opportunity for this kind of trading is during a bear market when stock prices across the board generally fall. This will almost certainly lead investors to sell off strong companies, providing you with an opportunity to buy in.

How Do You Buy the Dip?

First and foremost, you need to be careful and patient. A lot of advice on buying the dip has an aura of get-rich-quick schemes, otherwise known as timing the market. It’s extremely important to understand that timing the market does not work. You will almost certainly lose money if you try to swoop in while prices are low and cash out while prices are high.

Instead your goal is to act as a long-term investor capitalizing on opportunity. Yes, you want to take advantage of a low point in the market, but then you’re going to hold those assets. Just like under any conditions you should be investing for years, not weeks or months. The difference is just that buying the dip gives you a chance to goose your long-term profits.

A few pieces of general advice apply when you try to buy the dip:

Look for Bear Markets or Industry Downturns

The best time to buy the dip is when an entire industry or the market overall has suffered a shock. That’s a good sign that any individual asset has likely fallen because investors are scared overall, not because they’ve found a weakness in that company. Bear markets are excellent opportunities for this kind of investing.

In addition, track industry indices and look for sectors that have fallen significantly relative to recent benchmarks. The traditional signal is a 20% decline. When any sector of the market has dropped by 20% or more, it’s a good sign that you may be looking at a downturn you can capitalize on.

Invest in Index Funds

One of the best ways to invest in the stock market is through index funds. While these do reduce some of your potential gains from individual stock appreciation, they significantly reduce the potential risk of investing in individual stocks.

This is true for buying the dip as well. When you spot a market or a sector that has declined in a likely temporary way, your best move is to invest in a related index fund, either an ETF or mutual fund. This will put you in a good position to capture the gains of recovery while minimizing your risk of investing in a bad asset.

Follow Your Usual Rules More Aggressively

Under ordinary circumstances, you should be investing your money at a steady, sustainable rate. You should maintain a healthy emergency fund either in cash or low-risk, high-liquidity assets and your portfolio should reflect the balance between stability and growth. All of this should remain true when you buy the dip. The difference is that you will move more aggressively than usual.

Don’t just start shoveling money into the market. Continue to invest at a steady, sustainable rate that preserves your emergency savings. Just invest more money into the market than you usually would. For example, maybe take that vacation fund and put it into the S&P 500. Don’t start buying up individual stocks. Instead, keep your usual balance between speculative assets and safer assets. You can just buy more of each.

The key to remember when it comes to buying the dip is that the usual rules don’t go out the window. You want to continue making long-term investments at a steady rate. You just do so more aggressively than usual in order to capitalize on the current opportunities.

The Bottom Line

Buying the dip is an investing strategy where you buy temporarily underpriced assets. It can be a good response to a bear market, as long as you keep investing for the long term with your overall strategy. Be sure to proceed cautiously. It’s certainly wise to do so with the guidance of an expert like a financial advisor.

Tips for Stock Market Investing

The rule of thumb here is to keep investing according to your usual strategy, just a little more aggressively than usual. If you don’t have a strategy yet then it’s probably a good idea to speak to a financial advisor who can help you craft one for your goals. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
We can’t overemphasize enough that buying the dip is not the same thing as trying to time the market.