When it comes to investing, there are many terms, phrases and strategies that are often thrown about. Some of them make sense in context, while others may need a touch more explaining – like pound cost averaging, for example!
‘Buying the dip’, on the other hand, sounds a lot more straightforward – as long as you’re able to stop thinking about salsa and guacamole – but is it as simple in practice as it sounds?
What is ‘buying the dip’?
‘Buying the dip’ simply means to buy an investment when the price goes down – which is something that can happen when stock market performance falls. This is very similar to the investment strategy, ‘buy low, sell high’, but it typically takes a much more active approach.
While this idea isn’t exactly new, the phrase has become a bit of a financial meme thanks to social media platforms like Reddit. Just spend a few minutes scrolling through some Subreddits on the platform (especially where cryptocurrency is involved) and you’ll probably see ‘buy the dip’ being suggested as a solution for almost any situation where the price of an investment goes down – and that could be a drop of the slightest percentage or a huge crash in a single stock price.
How does buying the dip work?
In a way, the strategy of ‘buying the dip’ makes sense as you’ll pick up investments when their price has gone down. In one sense, you could think of it as being ‘on sale’ – you’re getting a discounted rate on an investment that you may have paid more for, after all. The hope here is that this dip is only temporary, and it will go back up to the price it was before it dropped so you can end up making a profit.
However, what a ‘dip’ is will depend on a wide number of things – for example, your attitude to risk, the length of time you’re investing for, and even the amount you’ve invested. A dip for some people could be a 1% drop, while for others it could be a market crash of 20%.
What this means is that there’s not really a specific rule as to what ‘buying the dip’ might mean for you, so you’d have to define it for yourself based on your personal circumstances.
For some people, the lower the price drops, the more potential that investment has – so instead of being shocked or worried about a dip in the market, it is treated as an opportunity. Now, in theory, this could work as the price of investments might go back up, but that’s not always the case. Sometimes the price of that investment keeps on falling and may never recover to the height that it originally dropped from.
It's worth remembering that with investing your capital is at risk, so while you could make a profit if the price goes up, you could also lose money if the price goes down.
How to know when to buy the dip?
This is a question that nobody really knows the answer to with a large degree of certainty. It could also become a very time-consuming and potentially expensive way of investing. This is because you’ll need to be constantly monitoring the markets for dips, which could easily start a deeper look into individual asset prices too.
If you’re a short-term investor, then you’ll typically be looking for much smaller dips and bounce backs, which means you’ll need to be very active to get the best prices for potential investments. However, if you’re a long-term investor, then your strategy may be to hold onto your investments for years, which could allow you to potentially achieve larger profits.
Can you buy the dip with indexes or funds?
Yes. Funds are one way to strategically buy the dip, as you can get a sense of a much bigger picture – this is because you’ll be looking at the whole market movement rather than focusing on specific companies or assets. Historically, markets have always recovered from market dips, but sometimes it can take years for this to happen. 
Is buying the dip a good strategy?
Yes and no. Buying the dip will not guarantee that you make profits. Just because the price is cheaper now than it was a day, week, or month ago, it doesn’t always mean that it’s a good value investment. It’s also worth pointing out that ‘buying the dip’ is more of a catchphrase than a strategy.
To use this as a strategy, you need to be able to understand why the value has dropped and know whether this lower value is temporary or a warning of what’s to come, and that requires a lot of research and in-depth knowledge. Similarly, if you choose to invest more in a single stock or asset type because its average cost has come down, then you could also change the overall investment risk of your portfolio – potentially opening yourself up to greater volatility.
If you haven’t got the time to do the research and analysis, then it may be worth thinking about using a managed investment service so that you could benefit from their expertise.
What are the alternatives to buying the dip?
We mentioned pound cost averaging (or dollar-cost averaging for the Americans) earlier, which is a strategy that allows you to ‘buy the dip’ while averaging out the amount you pay for your investments in total. For example, if you had a direct debit into your managed investment plan each month, then you might buy the same investment at £1, £1.70, £2, £4, £2.50, and £3. While you may have managed to grab a bargain at £1 and £1.70, your average cost of the investment would be £2.36, which helps to bring down the cost of those £4 and £3 purchases.
Pound cost averaging not only means that you could snap up some deals by buying the dip, but it could also help to smooth out your overall performance. By combining this approach with long-term investing, where you focus on time in the market rather than timing the market, then you could have a much smoother, more enjoyable investment experience.
If you’re not sure where to start when it comes to buying the dip or researching investments, then Wealthify could help. Our team of experts will do everything for you, such as building your perfect Plan and making all the investment decisions, which can make investing as simple as putting money aside for the future.
Please remember that past performance is not a reliable indicator of your future results.
With investing, your capital is at risk, so the value of your investments can go down as well as up, which means you could get back less than you initially invested.
You should seek financial advice if you are unsure about investing.
- Data from Bloomberg