What is ‘Buying the Dip’ and how can you do it?
Seize opportunity by buying low and selling high when you trade or invest on ‘the dip’. Discover what ‘buy the dip’ means and how to do it in this article.
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What does it mean to ‘buy the dip’?
To buy the dip is a tactic used by investors and traders to purchase (or go long on) an asset after its price has temporarily fallen in value. It’s the embodiment of the motto of ‘buy low, sell high’.
All markets have pullbacks and fluctuations. When a market suddenly trends downward for a short period of time, this is called a ‘dip’. Buying the dip means opening a position at this point, then aiming to sell when that market’s price has rebounded.
Buying the dip is one of the most intuitive trading tactics on the market because it speaks to the essence of good timing: buy when the price is lowest and sell when it’s at its highest.
What is a ‘buy the dip’ strategy?
When you use ‘buying the dip’ as a strategy, you’re hoping to make a profit from regularly buying your chosen market when it’s experienced a drop in price.
This generally means you’ll watch for a smaller downtrend that’s likely to be a temporary and minor shift in an otherwise upward-trending market. When this happens, you’ll buy, in the hopes of doing so when the price is at its lowest, just before the market’s value starts to rise again.
This will look different for all trading styles. Those with longer-term strategies will wait out bigger, more significant downturns, using their longer-term knowledge of the market to open one or just a few positions as close to the asset’s lowest point as possible. They’ll then likely buy and hold this position. This may take hours, days or even weeks.
If you’re a scalper or day trader, ie more in the short-term game, you’ll instead watch an asset’s chart closely for even the smallest fluctuations in value. These will be a large volume of shorter positions, each lasting just minutes, a few hours or even seconds before selling – hopefully at a higher price than you bought for.
What are the benefits of buying the dip?
There are several potential advantages when you buy the dip – but they depend largely on both the asset and the circumstances of the downtrend that you’re trading.
One instance is if the asset you’re trading is known to be of high quality, with a reputation for good returns and fair value for money. Here, if you time your buy correctly, you can lock in a lower average price for a position that’s usually worth far more.
Buying the dip can potentially be a way to make a profit (or a loss) if there’s a fairly certain, easy-to-predict period of volatility coming up.
Examples of these would include announcements like central bank updates from the Reserve Bank of Australia’s latest meeting, central bank stimulus or events like non-farm payrolls and earnings season. It could also be during macroeconomic headwinds like inflation, recession or bear markets. Even cyclical occurrences like a mean reversion or a retracement of that market would count.
However, to reap these benefits, it’s crucial to determine whether the ‘dip’ is really just a temporary downturn, or if it’s actually a market reversal. While the former is a downward fluctuation in value for a short time, a reversal means a fundamental shift where an upward-trending market becomes pessimistic on the whole, or vice versa.
It’s also worth mentioning that traders often use derivatives like CFDs to buy the dip. These are leveraged trades, meaning you’ll put down an initial deposit, called margin, to open a larger position. However, both profits and losses will be amplified as they’re calculated based on your total trade size. You could lose more than your deposit.
For example, you could be required to put down a 10% margin on a $100 trade, which would mean paying $10 to open a $100 position. However, profits and losses are calculated based on the total position size, the $100, so this can outweigh your $10 margin amount significantly.
How to use a ‘buy the dip’ strategy
During a dip, you’ll watch for a temporary downward fluctuation in price and then either purchase or go long on that asset. However, as we’ve said previously, it’s a tactic that’s better suited to some markets than others.
One of the most popular assets to buy during a dip are shares themselves. If investing with us, you’ll buy on our share trading platform and hold these stocks for some time. If you’d rather trade, you’ll go long (buy) when the price has dropped sufficiently to get it at a good price, then aim to sell to close your position after the stock’s price has risen as high as possible to make a profit.
When trading on a dip, you’ll likely use CFD trading. These are a form of derivatives, where you’re agreeing to exchange the difference in the market’s price from when you opened your position to when you closed it – whether that difference is a profit or a loss.
This, crucially, enables you to go long or short – because you’ll be taking a position, without taking ownership of the underlying asset. Instead, you’ll put down a fraction of your trade size as an upfront deposit, called margin, to open a larger position.
You’ll likely buy the CFDs in your chosen market when you feel the price has dipped as low as it’s going to, then sell after the price has rebounded.
Because the success of your buying the dip depends on how well you time the market, we offer signals from two third-party providers, Autochartist and PIA-First.1 Signals are suggestions about when to buy based on our data and analysis of emerging chart patterns. We also have trading alerts, which are notifications telling you that the parameters you’ve inputted have been reached in a market, and it may be time to buy or sell.
However, it’s important to note that CFDs are leveraged. This means that, although you’re trading on margin, both profits and losses are calculated based on your full position size, not your margin amount. So, profits and losses can both substantially outweigh your initial outlay. This is why a risk management strategy is key.
If you’re using CFDs, another popular market is indices. That’s because ‘buy the dip’ is commonly used when an obvious disruptor to market prices is near, eg central bank announcements. Indices are one of the markets most susceptible to these headwinds or tailwinds, as they represent the stocks of an entire index, and therefore are often bellwethers for an industry or even a whole economy.
With indices, you’ll go long on the index of your choice during a period of expected volatility, just after the price has dropped significantly but is showing signs of a bounce.
Investors who don’t want to hold stocks can buy an ETF instead, which gives broad exposure to a range of different stocks and assets across a sector or industry.
Examples of buying the dip:
On 13 October 2022, the Tesla Motors share price was valued at $218.99 at about 1.15pm. Then it dropped significantly between 1.25 and 1.30, to $208.34. Realising that a dip was happening, but believing that the market was still overall on an upward trend, you bought at the share’s buy price of 206.22 on our CFD trading platform at around 2.30pm.
You go long and buy 50 CFD contracts worth $10 each. You watch the share price go up and close your position at the sell price of 222.45 at 5pm – a difference of 16.23 points.
In this case, you’d have made a profit of $8115
(16.23 points × 50 contracts valued at $10 each)
However, let’s say your prediction was incorrect. You sensed a dip coming and went long, buying 50 CFD contracts worth $10 at the price of 206.22. Instead, the share price fell to 189.99 and you sold to close your position at 5pm.
In this case, you’d have made a loss of -$8115
(16.23 points × 50 contracts valued at $10 each)
Let’s look at a more long-term share trading example for investors. Say you watched the share price of Barrick Gold Corp dipping in the months of May to July 2018. In July 2018, you go onto our share trading platform and buy 100 Barrick Gold Corp stocks at the share price of $8.62 each.
Then, you hold onto the shares for a few months as you watch the price climb from August to November 2018, and sell when the share price is at $12.58 per share. The share price has appreciated between the ‘dip’ at which you bought and the point at which you sold, by $3.96.
This means you’ve made a profit of $396
(over and above the $862 you spent to open your position.)
If, however, you’d invested in 100 Barrick Gold Corp stocks at the share price of $8.62 each, but then the share price declined, you’d have made a loss. Say the share price declined by $3.96 over time, from $8.62 each to $4.66. At this point, you sold your shares.
This means you’ve made a loss of $466
(8.62 – 3.96 × 100 shares)
over and above the $862 you spent to open your position.
Commission charges are not included in the calculations above.
What are the risks and limitations when buying the dip?
While there are circumstances and markets where buying the dip has its advantages, there are also risks to using this strategy.
The biggest risk you’ll likely face when buying the dip is poor timing. To successfully open a position when a market is undervalued, then see it rebound, requires extensive knowledge of that underlying asset’s market history and prior movements
However, past results aren’t an indicator of future performance. There are no guarantees in investing or trading, meaning you could predict incorrectly or time the market wrong and make a loss instead of a profit.
A notable exception is that this won’t affect share trading investors with a ‘buy and hold’ strategy. Here, you’ll watch a share or an ETF you intend on owning for some time until that market dips sufficiently for you to buy at a lower price than usual, then wait again for it to appreciate in value over the long term.
There are also limitations and market periods where buying the dip won’t be an effective strategy. Because it relies on a rebound in the market’s price after dropping, ‘buying the dip’ only works in a bullish environment. If you mistake a significant downtrend for a small one, you run the risk of opening a position that will only lose you more and more money as the price continues to fall.
Because buying a dip as a trader means using CFDs, there is also the added risk of leverage. This means that your losses can significantly outweigh your margin amount, so ensuring that you trade within your means and have a stop order in place is key.
Buying the dip summed up
- ‘Buying the dip’ is the name for a tactic where you’ll go long or purchase an asset after its price has temporarily fallen in value, in order to hopefully make a profit when the price rebounds
- Buying dips is mostly used by traders in a short-term context, you can also buy during a downtrend if you’re an investor. Here, you’ll simply buy and hold the share or ETF for a longer time than you would as a trader
- However, the success of you buying a dip depends on the overall value of the underlying asset (it needs to be a market on the up in general) and on your timing
- Buying the dip as a trader means using CFDs. These are leveraged, meaning both profits and losses can significantly outweigh your margin amount, so ensure that you always trade within your means
You can also buy the dip as an investor, using our share trading platform. Here, you’ll purchase stock once it’s dropped in price and sell after the share price has rallied
1 The signal service does not constitute and should not be regarded as investment advice. IG provides an execution only service. You act on the signals entirely at your own risk.
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