What “buy the dips” means
– “Buy the dips” is the practice of purchasing more of an asset immediately after its price falls. The idea: the decline is temporary (a dip or pullback) and the price will recover, so buying after the drop gives a better entry price.
– Key related terms:
– Dip or pullback: a short-term price decline inside a longer move.
– Uptrend: a sequence of higher highs and higher lows.
– Downtrend: a sequence of lower lows and lower highs.
– Averaging down: adding to an existing position after the price falls, lowering the weighted average purchase price.
When the strategy tends to work — and when it doesn’t
– Tends to work best when the asset is in a confirmed uptrend and fundamentals are sound: dips are often temporary retracements that resume the trend.
– Fails when the price drop reflects a lasting change in fundamentals (weaker earnings, lost customers, insolvency). In that case “buying the dip” can mean “adding to a losing investment.”
– Buying dips in a downtrend is risky; only long-term investors who accept very large drawdowns should consider it.
Practical checklist before you buy the dip
1. Confirm trend: is the asset in an overall uptrend (higher highs, higher lows)?
2. Re-check fundamentals: any new negative news that changes intrinsic value?
3. Define time horizon: short-term trader vs long-term investor — your rules differ.
4. Position size limit: maximum percentage of your portfolio to allocate to this single asset.
5. Entry rule: price level or technical signal that triggers buying.
6. Risk control: set stop-loss price or maximum dollar loss per trade.
7. Diversification: avoid concentrating too much in one name.
8. Exit plan: profit target, trailing stop, or fundamental trigger to re-evaluate.
Step-by-step process (simple routine)
1. Identify candidates: choose assets in healthy uptrends with stable fundamentals.
2. Wait for a defined dip: e.g., a pullback of X% from recent high or a support level test.
3. Enter with a pre-sized order (limit order at your chosen price).
4. Place a stop-loss to cap potential losses (percentage or price level).
5. Monitor: if fundamentals deteriorate, tighten stops or exit. If trend resumes, consider trailing stops to lock gains.
Worked numeric example (averaging down + stop-loss)
– Scenario: You initially buy 100 shares at $10 = $1,000 invested.
– The stock falls to $8. You decide to “buy the dip” and purchase 50 more shares at $8 = $400.
– New total shares = 150. Total cost = $1,000 + $400 = $1,400.
– New average price = $1,400 / 150 = $9.33 per share.
Risk control: you set a stop-loss at $7 (meaning you will sell if price hits $7).
– If stop triggers at $7: proceeds = 150 × $7 = $1,050 → loss = $1,400 − $1,050 = $350 → percent loss on total capital = $350 / $1,400 ≈ 25%.
– If instead the stock rebounds to $12: proceeds = 150 × $12 = $1,800 → gain = $1,800 − $1,400 = $400 → percent gain = $400 / $1,400 ≈ 28.6%.
This example shows how averaging down reduces your average price but increases exposure, so losses can be larger if the asset keeps falling.
Common variations and slang
– Averaging down: adding to a losing position to reduce average cost.
– BTFD: internet slang for “buy the f—ing dip”; implies aggressive buying in hot markets (high volatility).
Limitations and psychological pitfalls
– It’s hard for most investors to distinguish a momentary dip from the start of a deeper decline.
– Averaging down can magnify losses if you keep adding to a failing position.
– Confirmation bias: investors may focus on past winners (e.g., Apple after 2009) and ignore failed examples (companies that went bankrupt in 2007–08).
Risk-management checklist (quick)
– Max allocation to single security (e.g., 2–5
% continued from previous checklist %
– Max allocation to a single security (e.g., 2–5% of total portfolio). This limits concentration risk.
– Maximum cumulative add-on budget for averaging (e.g., no more than 1–3 additional purchases or a fixed dollar cap).
– Cash buffer (emergency reserve equal to 3–6 months of living expenses) so forced selling is less likely.
– Predefined dip trigger (e.g., buy only on a 5–15% decline from your purchase price or from a recent high).
– Position-size rule for each add-on (e.g., add 25–50% of the initial position size per step).
– Maximum tolerated drawdown per position before closing (e.g., 15–40% depending on risk tolerance).
– Use limit orders to control execution price and avoid chasing fills at the wrong moment.
– Check liquidity and news before committing capital (low-volume stocks and fundamental red flags increase risk).
– Periodic review and rebalancing schedule (e.g., monthly or quarterly) to enforce discipline.
Step-by-step decision checklist (practical)
1. Define candidate: confirm the asset passes your fundamental or technical filter (business quality, earnings, trend support, etc.).
2. Set limits before you trade: cap allocation, max add-ons, dip trigger, stop-loss or exit rule. Write them down.
3. Size the initial trade consistent with your allocation limit.
4. If the dip trigger is hit, confirm there’s no new negative structural information (earnings collapse, fraud, etc.).
5. If you still like the trade, buy a predetermined amount using a limit order.
6. Record the trade and update remaining add-on budget.
7. If further declines happen, follow your pre-specified add-on plan or stop out if stop-loss/closure criteria met.
8. Rebalance periodically to the target allocation.
Worked numeric example (shows how averaging down changes average price and exposure)
Assumptions:
– Portfolio value: $100,000
– Maximum allocation per security: 3% ($3,000)
– Initial buy:
Initial buy: $1,000 at $50 per share = 20 shares.
Dip schedule (pre-specified):
– Trigger 1: price falls 20% from $50 to $40 → Add $1,000.
– Trigger 2: price falls another 20% from $40