When Traders Say ‘Buy The Dips’…

Posted on February 5, 2016 at 4:44 PM PST by

Everyone loves a bull market. Stocks don’t rise in a straight line, of course, but that’s okay because just about everyone has a plan.

Buy and hold is one way. Another, favored by active traders, is to “buy the dips,” that is, to buy more when stocks fall back.

After all, it’s a bull market. You probably feel relatively certain that buying declines is a good idea — if that good feeling is rewarded soon after by a new market high.

There’s a certain logic to buying dips in a bull market, but not all markets are obviously bull markets and not all bull markets last.

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What on earth do you do when a correction kicks in and stock prices fall? You might buy a dip and see the price go down from there. If it’s a real bear market, things could turn ugly for a while.

The “buy the dips” idea does work to a degree, if instead you call it “dollar cost averaging.” With DCA, as it’s known, you don’t try to figure out when a dip is a dip. You simply invest the same amount every paycheck, every month or every quarter, whatever makes the most sense to your cash flow.

If you do dollar cost averaging right, you end up buying the dips without any effort at all. Your dollars buy more shares when the price is lower and fewer when the price is higher. It averages out to a generally lower “get in” price than if you had tried to guess the lowest points in any period of time.

If you like the automated logic of DCA, why not take buying the dips to its logical conclusion — rebalancing.

Like DCA, rebalancing is best done as a periodic, disciplined practice, something you do whether it makes sense in the moment or not.

You don’t brush you teeth because they feel dirty; you brush daily to stay on top of good hygiene. Same idea. Just do it, and don’t worry so much about why.

As you rebalance, you end up buying the dips because that’s what rebalancing is. You sell a portion of your portfolio that has exceeded its target and buy something else in the same portfolio that’s below target.

Bump and dip

For instance, if you had a 60% stock and 40% bond portfolio and the stock portion rose in value, you would first calculate by how much.

Let’s say it’s now 65% of the dollar value of your portfolio. Bonds, then, now represent 35%, even if they haven’t changed in value at all.

Just like brushing and flossing, you sell that extra 5% and use the cash to buy bonds. You’re back to 60/40, just like before.

You just sold a bump to buy a dip. Just like a stressed-out Wall Street trader trying to catch a low point in the market by luck, only you don’t have to deal with the stress and, over time, your return is going to much better than most traders.

It’s brainless investing, but that’s a good thing. Brains are useful, but they also trick us with emotions and misperceptions. Better to have a discipline and let it do the work.

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