Buying the Dip Isn’t as Easy as You Think

Buy the dips…

Your friend, your college professor, even your mom has probably given you this advice.

It seems simple. When stocks pull back in a bull market – like the one we’re in today – you seize the opportunity and buy quality stocks at a discount. Naturally, these quality names don’t remain cheap for long. You make money as they shoot right back up to new highs.

Obvious, right?

But buying a market dip is more challenging than you might realize…

Think back to the end of last February… Did you buy the dip as stocks fell their first 12%? If you did, you probably felt pretty good as they quickly climbed 6% in the following days. You probably thought you outsmarted everyone else who was panicking…

But as we all know now, that wasn’t the dip you wanted to buy. After the market briefly rallied, stocks plunged more than 28%.

Now, this is an extreme example. No one knew what to make of the market last February and March. The pandemic was truly a black swan event.

But even looking at a somewhat “normal” market correction… did you buy the dip at the end of 2018?

Stocks fell 10% – the standard definition of a market correction – before they rallied 6.5%… and it looked like the market was back on track to hit new highs. But stocks weren’t done falling yet. By the end, they had fallen nearly 20%.

If you bought either of those dips and held on, then your strategy paid off. Stocks eventually went on to make new highs. But you needed nerves of steel to hang tight through all the volatility.

Now, think about this… What if you were waiting to buy a big dip any time after last March?

Say you told yourself that when stocks fell 10%, you’d jump back into the market. You’d empty your bank account into Amazon (AMZN), Apple (AAPL), Berkshire Hathaway (BRK-B)… all the high-quality stocks you want to own.

If this was your approach, you would never have moved your money out of your account. The market hasn’t dropped more than 10% since the end of March 2020. Your cash would still be collecting less than 1% interest. And you would have missed all of the incredible gains over the past several months.

Plus, when there are dips in the market, there’s typically very little time to get the prices you want. Stocks usually recover quickly. You may miss your opportunity to buy if you don’t act fast enough.

The point is that buying dips isn’t as easy as folks make it out to be. Timing the market never is.

That’s why you shouldn’t play that game…

Instead, focus on what you can control. Use proper position sizing. Follow your stop losses. Diversify across different sectors, assets, and countries. And most important, especially for today, own quality stocks.

The truth is that a market crash is coming. I don’t know when. But it’s clear the market is in a state of euphoria.

Stocks are up nearly 75% since last March. There are plenty of other signs, from the speculative action with retail investors driving up lousy stocks like GameStop (GME) and AMC Entertainment (AMC)… to today’s record stock valuations… to an environment of extremely bullish option activity.

Now, you can think about this euphoric behavior in two ways…

First, pullbacks are a normal part of the market cycle. During the last great market Melt Up in 1999 and 2000, there were plenty of times when the market fell about 10%…

Nothing goes up in a straight line forever. We’ve already seen a correction in the Nasdaq. Many investors have been saying we’re overdue for a 10% drop in the S&P 500 – and I tend to agree with that. Stocks need a breather, especially since we’re not out of the woods with COVID-19 yet.

The other way to think about today’s speculative market is that it can keep stocks going much higher… for much longer than you might anticipate.

If you only focus on buying the dips like I talked about earlier, you could miss out on some spectacular gains to come… as giddy investors keep throwing money at stocks.

Today’s market environment is tricky. You don’t want to take out a second mortgage to invest only to end up homeless a few months down the road… and you don’t want to sit on the sidelines and miss out.

Stay in the game. But be realistic about the market we’re in today. Use the risk-management tools I talked about earlier. And take a hard look at your portfolio to be sure that you’re holding quality companies.

Here’s to our health, wealth, and a great retirement,

— Dr. David Eifrig

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Source: Daily Wealth