“Buy the dips” is a common expression in the investment business. I use it myself. But what exactly does it mean? Well, one size does not fit all, of course, but I may be able to help…
First, some basics:
- The idea of buying the dips is to use normal volatility to get better prices for something one is highly confident of.
- This is not the same as buying on small, high-frequency volatility that wouldn’t be noticeable on a day-to-day basis.
- It’s also not the same as waiting for a major correction to average down aggressively.
- Buying the dips would be a mistake if there’s a change in relevant market trends or if there’s actual bad news specific to the stock or other asset in question.
So, how do we know what a dip is?
A simple way to define it is to set an arbitrary percentage. One could, for example, set 5% price fluctuations as dip triggers.
But some volatile junior stocks fluctuate 10–20% on a daily basis, while a 5% drop in a major company is often a sign that something has changed or there’s a problem with the company.
Setting arbitrary price differences would be worse. Obviously, a $0.10 fluctuation in a $50 stock is not the same as it would be in a $1 stock.
What I do is look at trading data to estimate the typical volatility for that specific stock or asset.
That’s important. I don’t apply the same numbers to everything in the same class. I use only the price fluctuations for the specific stock—and I limit that data to the current trading range or the most recent weeks. Price volatility from a period when the market was more bullish, bearish, or bored would not be as relevant as data in the current market context.
I then set a price range that would be hit if the stock dropped more than usual, but would be exceeded if the stock drops too much.
The latter is very important as well. If the stock is crashing, I don’t want to buy without looking into why. If I decide the price crash is unwarranted and buy anyway, then I’m not really buying a dip; I’m being a Rothschild contrarian and buying while there’s blood on the streets. When I’m buying the dips, I’m just looking for something slightly greater than normal volatility.
What’s normal volatility?
I determine a relevant timeframe and average the typical fluctuations over that time. There’s a lot of math one can throw at this, but simple arithmetic averages are good enough for me. And honestly, this is one of those things where eyeballing a chart can give you a very good feel for it at a glance.
Then we get to the tricky part: setting dip-price trigger ranges.
I’d like to say that anything from 1.1–2x normal volatility constitutes a dip, but the reality is that even that is just a starting place.
- A more aggressive speculator might want to define it as 1.5–3x normal volatility.
- A more risk-averse speculator might want to define it as 1.1–1.5x normal volatility.
- Someone trying to buy before expected good news hits the wires might go for a much easier 0.5–1.5x normal volatility.
- Even for the same person, it’s different when you already own the stock and are looking to add to your position (you’ll want more aggressive trigger ranges) vs. buying for the first time (you’ll likely want easier to reach triggers).
Unfortunately, there’s no single formula. But I do hope you find these thoughts on what I do when I’m looking to buy the dips helpful.
P.S. For more general tips for speculators, please read my Speculation 101 and Natural Resource Commodities 101 primers, if you haven’t already done so.
