5 min read

Buying the Dip is not a Strategy

Buying the Dip is not a Strategy
Photo by Dennis Klein / Unsplash

Given the tumultuous period in financial markets recently, let's take a look at markets as they currently stand, and how I'm thinking about investing in the near future.

The article is broken down into the following segments:

  1. Holdings and Mentality Update
  2. Buy the Dip?
  3. Buy the Trough?

Hope you enjoy!

1 | Holdings and Mentality Update

I haven't been checking my equity and crypto holdings as frequently in the last few months...

I've adopted an 'ignorance is bliss' mindset, hoping that long-term conviction will help me ride out the recent market turbulence.

While mentally convenient, this hasn't been the best strategy. The best time to invest is always when markets are at their worst.

Nonetheless, market conditions will change significantly as the effects of excessive stimulus and mispricing is withdrawn to reveal true supply and demand dynamics.

Most risky assets had traded well above their intrinsic value for too long, buoyed by retail investor hype, wild speculation and leverage.

Even as we move into October, the situation hasn't improved. While it may be easy to forget about your holdings and retain hope in the 'long-term', it is often irresponsible. Even if you're not trading, monitor your positions and stay on top of the news.

It's never easy to stare at a screen of red and crystallise a loss by selling your position. It's never easy to accept, once and for all, that you were greedy, or influenced by media hype rather than fundamental valuation. However, it is often a necessary step to crystallise a change in behaviour and to learn a lesson from failure (as well as beef up your tax loss account for the next financial year haha).

I recently filed my tax return, and to my disgust, made profit in the last financial year (Jul 2021 - Jun 2022). While this may sound like I've done a good job with my investments given the market carnage of the last 6 months, it's really just an indicator that I'm sitting on extensive unrealised losses. Lovely.

I've been inactive in markets for the better part of this year. This has been a fortunate product of (a) being unable to trade during my summer internship, and (b) extensive liquidity required for my exchange program and travels around Europe in the second half of this year.

I liquidated all of my winning positions in November 2021, and am extremely grateful for it.

As the calendar year turns over, we may begin to see a silver lining, and opportunities to re-enter may arise. Continue to be cautious, but actively engaging, educating yourself, and scrutinising market movements and conditions.

2 | Buy the Dip?

I am highly critical of the investment advice given on several social media platforms to 'buy the dip' when markets begin to face periods of stress.

Markets are forward-looking. Current prices reflect expectations of the future. However, in a future that is increasingly uncertain, we can never know whether prices have fully incorporated the downturn to come.

It is foolish to believe that a dip in prices is always an opportunity to buy. Following the COVID-19 pandemic, the 'buy the dip' strategy was extremely successful, but it is important to understand why.

The rebound was driven by government stimulus, which artificially propped up businesses and households. This was an attempt to prop up the economy during a period of extreme fear and uncertainty.

In the US, the Federal Reserve then continued to provide stimulus as inflation was already well above 5%. As a result, their recent attempts to remove liquidity from markets and begin quantitative tightening has had an outsized impact in the opposite direction: downwards.

Buying the dip has been an extremely poor performing strategy this year, and it is a strategy which has been naively followed by several retail investors looking to repeat their 2020/21 investment strategies.

The WSJ reports that "the S&P 500 has dropped 1.2% on average this year in the week after a one-day loss of at least 1%", the biggest decline since 1931. Put in practical terms, if you were to buy a dip of 1% in the S&P500 index, you would face another 1.2% loss in the following week.

Based on the discussion above, it is no surprise to me that 'Retail, or nonprofessional, investors have been enthusiastic dip buyers, piling in even when institutional investors are coming out.'

It is often wise to follow the professionals. Blindly 'buying the dip' is not an investment strategy.

Markets have been down for months now, 30 yr variable rate mortgages have skyrocketing to over 7% (in the US) and the simple truth is that people will struggle to service their loans. For those who have incinerated their stimmy checks in the stock market, it's definitely an uphill battle.

We're also beginning to see more prudent expense management, even from the largest and most cash-rich businesses globally. Apple has cut back on production of iPhone 14 due to underwhelming demand, and Facebook has announced a hiring freeze as growth begins to slow.

3 | Buy the Trough?

It's possible that buying a 'dip' is a bit of a misnomer at this point. As depressing as the macro news is, there may be a light at the end of the tunnel.

At market bottoms, we begin to see consolidation. Weaker companies turn over and stronger companies capture market share and begin to spread their roots for the next cycle.

Human capital also begins to consolidate and we begin to see a greater consolidation of real talent at startups and large organisations, who are now more careful and purposeful with their hiring decisions.

As malaise and disillusionment begins to set in, now may be the time to start actively engaging with the market and looking for more signs of consolidation.

Are companies demonstrating financial prudence? Are they trimming the fat and focusing on core operations?

Despite the challenging macro environment with the Nordstream pipelines, the ongoing Russia-Ukraine conflict, a spiralling pound in the UK and tension between Turkey and Greece, financial markets appear to be consolidating.

Now deep in the trough, we may be bottoming out. Yet we will never truly be able to predict how long this bottom will last. Markets often bounce around the bottom as consolidation occurs, and this process may take several years. The following tweets from Michael Burry demonstrate this well. Clearly, he believes that there is still further to go.

To summarise...

My role will never be to provide advice on how to invest. My aim is always to provide an outline of the financial environment, and hopefully give some useful pointers about how I'm thinking about market conditions.

Thank you for reading this far! If you've found this article useful, please consider subscribing to the blog, absolutely free of charge. I only publish once or twice a week, so your inbox is safe!

All the best, and keep winning!