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A common recitation of late is to ‘buy on the dips’, and indeed in upward trending markets this certainly seems to be a wise policy. But as with so many self evident truths, it offers little practical use to investors.
For starters, how do you define a dip? One could offer the following characterisation: a dip is a short term pull back in price followed soon afterward by a recovery to previous levels. After all, if it didn't quickly recover it wouldn’t be a dip! Here lies a real problem; it is only identifiable in hindsight! During the initial pull back, how do you know that it will ultimately prove to be a dip, rather than the start of a persistent downtrend? Furthermore, what will the magnitude of the dip be? Analysis of recent price action may suggest a lower limit for the dip, but again we will only ever know after the fact.
Another issue is that it contradicts a favourite axiom of traders; that is, ‘you shouldn’t try and catch a falling knife’. This essentially says you shouldn’t buy into a falling market, but if I am buying on a dip, aren't I essentially doing just that? If I wait for a reversal to be confirmed, don't I then miss out on the majority of the upside following the initial pull back?
Another problem that often results is that investors miss out on better gains because they pay too much attention to short term price volatility: something that should be largely irrelevant to true investors. Investors looking to get into a stock often forego significant gains all because they end up waiting for a pull back that never comes.
If you like a company and it is currently trading at a price that offers reasonable value, just buy it. Waiting for a dip, and then correctly timing it may provide you with a slightly better return, if indeed it all goes your way. But the added benefit is probably going to be reasonably insignificant, and likely not worth the risk if things don't go your way.
As always, prior to making any move in the market you need to strictly define exactly what your goals are. Are you looking to speculate on some short term price action? If so, ensure you have very stringent risk mitigation strategies in place.
On the other hand, if you are looking for a longer term relationship, particularly with a company that will reward you with regular and reliable cash payments, greedily hoping for a small short term drop is highly unlikely to provide you with any real benefit. Besides, even if you miss out on a slightly better buying opportunity, it is hardly likely to amount to a huge difference.
For example, 9 years ago I purchased BHP at $8.75 only to watch it drop all the way back to $7.45 shortly after. Naturally I kicked myself at the time, after all I experienced a near 15% drop and although it was short lived I was annoyed that I had missed out on a better buying opportunity. But today do I really care? Since then, I have received $5.15 in dividends per share (that’s a total yield of almost 60%) and I have an average annual total return of 21%. Had I managed to time the dip correctly, I would instead have an average annual total return of 23%. That’s not an insignificant difference, but it hardly engenders any feelings of regret on my part.
The fact is that virtually every single trade we ever make can be improved on with the benefit of hindsight, and as such is a largely useless exercise. This isn’t a game of perfection or bust. What matters is that you gain ownership, at least in part, of a highly profitable business. One that is committed to share its profits and offer the potential for attractive, compounding returns.
Make the markets work for you
Andrew Page
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