Buying Dips Unpredictable?
Buying dips is great in a growing stock market, but volatility could take its toll on this strategy.
If there is one strategy that’s commonly followed in stock trading and investing, and which even people unfamiliar with the stock market can understand, it is buying stocks when their value dips. This strategy is powered by the hope, and indeed the strong feeling, that these stocks will rise in value following this period of dip. With the United States enjoying a long bull market, this strategy should work day in and day out.
Indications of Tremendous Growth Are There
Analyst and prominent economist Milton Ezrati points out in an Investopedia article that 2018 provides every indication of great growth. The economy has momentum and there is greater consumer confidence which should result in more spending. This could have an impact on home-buying too since homebuilding has been trailing family formations. There has also been a strengthening of capital spending by businesses. The corporate tax relief should contribute to sustain this capital spending. But Ezrati himself warns that this recovery won’t last forever.
Hard to Predict What Happens After a Market Dip
Investopedia’s experienced analyst Mark Kolakowski sends out a warning signal stating that no one can predict if the next market dip is just a blip in the stock prices or the start of something deeper, a market correction that causes it to slip by 10% at least. It could also indicate the start of a bear market that could bring prices down by over 20%.
This isn’t to hamper your enthusiasm but just to encourage you to embrace research before buying stocks just because they’ve dipped. Analyst opinions are important, and major investors have suggested a melt-up to happen in the stock prices, according to The Wall Street Journal. Prominent investors such as Jeremy Grantham hold on to this viewpoint which also indicates that the strongest surge in stock prices usually occurs as a bull market cycle is about to end.
A Stock Price Melt-up Expected
Grantham did mention his expectation of a sharp stock price melt-up that could last from six months all the way to two years, which would be followed by a really sharp decline. The growth expectations are fueled by factors such as the strong global economic growth and the continuing rise in corporate profits. The tax reform has also helped accelerate the profits.
Through the February 6 close, the S&P 500 Index ($SPX) experienced a decline of 6.2% from its January 26 record close. The Dow Jones Industrial Average ($DJIA) also had a 6.4% decline from its all-time record. These indices then managed to post gains to recoup some of the big losses they suffered on Monday, February 5. However, Kolakowski believes one can’t say for sure if the selloff has managed to run its course. It’s just too early to say.
Dow Stocks that Have Performed Worse than Market Averages
Some of the stocks in the Dow have even performed worse than the averages of the market during this time period. These include Chevron ($CVX) which went down 11%, Exxon Mobil ($XOM) which sunk 11.9%, Johnson & Johnson ($JNJ) that was down 9.4%, 3M ($MMM) that sunk 8.6%, and Intel ($INTC) that slipped 7.3%. Kolakowski points to these stocks and reasons that their share prices fell more than the Dow and the S&P 500 market indices because of other factors specific to the industry or company that were probably at play.
Buying Dips Is a Great Idea If You Do the Research
Buying dips provides no guarantees regarding a stock price or market index rebound. Besides, this recent stock price downturn has also been accompanied by a significant rise in market volatility, according to the CBOE Volatility Index (VIX). Speculators have made risky bets, expecting the continuation of the low volatility that characterized much of 2017. But the volatility has increased. But speculators, hedging their bets on low volatility, engaged in “short-vol” trade. Sothey suffered as this strategy fell apart following the February 5th selloff, and even before that right from January 26 when the volatility returned. The Wall Street Journal reports on this.
So Kolakowsky concludes that the stock trading and investing lesson to learn from this is not to buy stocks just because they have significantly dipped in value, but to research the stock’s fundamentals to know if it is in for a longer-time decline. If so, you need to avoid it.
Being able to go long and short is crucial for successful trading. As is keeping down fees. TradeZero provides the largest availability of short locates anywhere, in addition to commission free stock trading.
This content is restricted to site members. If you are an existing user, please log in. New users may register below for FREE.