What is 'Buy the Dip' All About?

Lately, you would have observed the phrase ‘Buy the dip’ become a common refrain among your investing keen friends. With the market being topic of conversation and the latest market volatility, ‘Buy the Dip’ is a term often thrown around toward novice investors. But, is it an advice you should be taking? Is buying the dip right for you?

Before we get into the details of the different aspects and elements of buying the dip, let us understand, what does buying the dip mean?

'Buying the dip' is a strategy where investors buy more of an asset after its price has temporarily fallen. The hope is that the price will go back up, allowing them to profit. This is often done with assets that are considered fundamentally good but have seen a temporary price drop due to wider market issues.

Usually, investors who 'buy the dip' aim to increase their stake in an asset at a lower price, anticipating a recovery or market correction that could help with generating profits through their investments. However, prudent investors don't jump in blindly. They base their 'buy the dip' decisions on thorough research and analysis in order to properly recognise the risk involved in increasing their exposure to a potentially declining asset.

How does buying the dip work?

In context of mutual fund investing, “buying the dip” refers to the strategy of purchasing additional shares of a mutual fund after its Net Asset Value (NAV) has experienced a recent decline. This is based on a strategy where one assumes that the drop in price is temporary, and that the fund’s NAV will eventually recover.

Just like investing in stocks, investors in mutual funds also pay attention to the fund's NAV and its historical price movements, often visualized through charts. A downward trend or a sharp drop can be seen as a 'dip.' Buying at this dip is considered a tactical decision which is usually a part of a larger strategy.

When considering such tactics, it is important to note that while major stock market indexes have historically recovered from significant drops, it’s not a guarantee that all mutual funds or specific assets that they hold will necessary bounce back.

Basically, if a mutual fund's NAV drops due to a market correction, but the underlying companies in its portfolio are still fundamentally sound, an investor might see this as an opportunity to 'buy the dip' and acquire more shares at a lower price, anticipating a future rebound in the market and the fund's NAV.

Is buying the dip a good strategy? The appeal of buying the dip

The major appeal of buying the dip is the classic “buy low, sell high” strategy. A lower entry point converting to a higher percentage gain. Further, this tactic aims to take advantage of the market fear. Market downturns can be unsettling, and many investors panic and sell, contributing to the downward pressure. Buying the dip goes against this herd mentality. It's a contrarian approach that can feel empowering.

However, one needs to keep in mind that there is no such thing as a perfect strategy. The reason this strategy works for some is because it aligns with a long term horizon looking at temporary downturns as opportunities instead of threats. It makes use of the fundamentals of cost averaging, allowing you to acquire more assets during dips and potentially lowering your average cost per share over time. Moreover, market corrections can sometimes lead to fundamentally strong assets becoming temporarily undervalued. Buying the dip can be a way to capitalize on the temporary mispricing.

The risks of buying the dip

Buying the dip, while tempting, carries considerable risks. Sometimes, what appears to be a temporary downturn could easily be the start of a prolonged decline, leaving investors with depreciating assets. Attempting to time the bottom can lead to 'catching a falling knife,' where continuous purchases are made as the price keeps dropping instead of the expected correction. Buying the dip also carries the risk of misinterpreting the reason for the decline. A price decrease might signal fundamental problems rather than a buying opportunity. The emotional toll of sustained losses could also trigger panic selling at inopportune times, solidifying losses.

Repeatedly buying the dip of a specific asset could lead to over-concentration, increasing portfolio vulnerability. This also means that your portfolio will not be diversified leaving you further open to market volatility. The financial strain of deploying more capital during dips can also become problematic if the decline continues. Accurately predicting the bottom is notoriously challenging, and capital tied up in a dip that doesn't recover represents an opportunity cost, potentially missing out on better-performing investments. Therefore, a cautious and well-researched approach is crucial when considering this strategy.

Alternatives strategies you could try

Rupee-cost averaging offers a less volatile approach by spreading investments over time, mitigating the risk of mistimed large purchases. Another tactic involves buying on the way up or prioritizing momentum over catching the absolute low. Ultimately, focusing on fundamentally strong, high-quality assets with a long-term view can help in providing relatively more stable returns, irrespective of short-term market dips. These alternatives emphasize a more measured and less reactive approach to investing, potentially leading to more consistent portfolio growth.

While 'buying the dip' might seem like a straightforward way to profit from market downturns, it's essential to weigh the potential rewards against the inherent risks. A successful investment strategy goes beyond simply trying to time the market. It involves a disciplined approach, thorough research, and a focus on long-term goals. This is also where investing through SIPs could be an approach more suited to your investment strategy. SIPs allow you to benefit from rupee cost averaging and inculcate a practise of more disciplined investments, making long term wealth creation easier and helping you not worry about market situations.

Remember, building a resilient portfolio is about making informed decisions that align with your individual circumstances and financial objectives. To help you plan your investment better, you can check out our Calculators and Tools to help you build your ideal investing strategy. For easier access to these tools, you can also download the Axis Mutual Funds app.

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This document represents the views of Axis Asset Management Co. Ltd. and must not be taken as the basis for an investment decision. Neither Axis Mutual Fund, Axis Mutual Fund Trustee Limited nor Axis Asset Management Company Limited, its Directors or associates, shall be liable for any damages including lost revenue or lost profits that may arise from the use of the information contained herein. No representation or warranty is made as to the accuracy, completeness or fairness of the information and opinions contained herein. The material is prepared for general communication and should not be treated as a research report. The data used in this material is obtained by Axis AMC from the sources which it considers reliable. While utmost care has been exercised while preparing this document, Axis AMC does not warrant the completeness or accuracy of the information and disclaims all liabilities, losses and damages arising out of the use of this information. The AMC reserves the right to make modifications and alterations to this statement as may be required from time to time.

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