What is ‘buying the dip’ and how can you do it?
Seize opportunity by buying low and selling high when you trade 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 traders to purchase (or go long on) an asset after its price has temporarily fallen in value. It’s the embodiment of the motto ‘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 a 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 drop in price that you’re trading.
One instance is if the asset you’re trading on 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 profit (or a loss) if there’s a fairly certain, easy-to-predict period of volatility coming up. Examples of these would include updates from the European Central Bank or the Federal Reserve latest meetings or events like earnings season. It could also be headwinds like inflation, recession or bear markets. Even cyclical occurrences like a pullback of that market would count.
Trading on uncertainty in this way can increase your chances of profits, but it’s worth mentioning that volatility also increases your risk when trading.
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 buying a dip as a trader means using derivatives like CFDs. These are leveraged trades, meaning you’ll put down an initial deposit, called margin, to open a larger position. This can be lucrative – but only if you predict and time your trade correctly, as both profits and losses are calculated based on your total trade size.
For example, you could be required to put down a 10% margin on a CHF100 trade, which would mean paying CHF10 to open a CHF100 position. However, profits and losses are calculated based on the total position size, the CHF100, so can outweigh your CHF10 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 go long, trading via CFD trading. CFDs are a form of derivative, 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 enables you to go long or short – because you’ll be speculating, 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 your success depends on how well you time the market when buying a dip, we offer signals, which 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.
Still, it’s a tactic that’s better suited to some markets than others. One of the most popular assets to trade during a dip are shares. You’ll go long (buy) when the price has dropped sufficiently to get it at a lower price than is usual, then aim to sell to close your position after the stock’s price has risen, to make a profit.
Another popular market to trade is indices. That’s because buying a 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.
Example 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)
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.
Probably the biggest risk to do with 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 isn’t an indicator of future performance. There are no guarantees in trading, meaning you could predict incorrectly or time the market wrong and make a loss instead of a profit.
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 on an asset after its price has temporarily fallen in value, in order to hopefully make a profit when the price rebounds
- Buying dips will mostly be used by you if you’re a trader in a short-term context, where you’ll buy at a low price and sell after the price has rebounded
- 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
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