Volatility forces a rethink of ‘buy the dip’ approach

To “Buy the Dip,” or not?

There’s a lot of content out there on why this strategy is a bad one and how it traps investors. Done right however, this strategy is one of the few that can generate exponential returns.

 Firstly, buying the dip is best done following a black swan event or total market collapse where destruction is widespread and indiscriminate selling occurs across the entire market with no one survivors. Not even gold stocks. Everyone is hit. Selling is driven by fear, panic and capitulation.

With the Australian market taking a nosedive last week, it doesn’t mean doom and gloom, sell everything. The sell-off was merely a reaction to rising inflation. A rotation out of overvalued tech stocks and into value stocks. This is a time to use the dip as a buying opportunity to load up on high-quality value stocks that are trading at bargain prices.

Warren Buffett once said that it is wise for investors to be “fearful when others are greedy, and greedy when others are fearful.” After last week’s sell off, sentiment couldn’t be any more lower. Buying the dip, follows stockmarket 101’s basic principle, ‘buy low, sell high’ but with a slightly more target approach.

‘Buy the dip, after a sharemarket beating, in only stocks that are likely to rise again’

During a sharemarket beating, stock prices fall across the board in a sea of red, as investors sell indiscriminately. Fear and panic set it. Selling occurs usually as the result of a change in economic trend. Last week, rising inflation fears drove panic selling. High growth stocks were hit hardest, and value stocks fell as well.

What we’re looking for, are high-quality value stocks with rising earnings, that were caught up in this market rout and were unfairly sold off. Here is a list of the stocks sorted by how much they lost in the month and their broker earnings per share rating.

Looking at the table above, it’s clear that brokers favour the high-quality value stocks that have dropped this month. Companies that had a negative EPS or low EPS, didn’t make the list.

When should you buy?

Let’s get one thing clear, no one knows when the bottom is. So trying to pick it, is a mug’s game. Instead of trying to time the market, you have two options. You could buy now, but that means you will run the risk of experiencing volatility until the stock rebounds. Or you could wait until there is confirmation of the recovery but some of the upside potential will be lost.

Sometimes investors might want to wait for some price consolidation before jumping in. That way ‘buying the dip’ is confirmed and not mistaken for a case of ‘catching a falling knife.’

Ishan Dan

Ishan is an experienced journalist covering The Inside Investor and The Insider Adviser publications.