Friday, 16 October 2015

Is It Always Best to Buy At Dips?

Paying sky high prices for your investments is definitely not a good idea to grow your money. So, is the opposite, buying during the dips, a much better strategy to follow? I think so, but we also have to be careful when applying it as well

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Buying shares and other investments at lower prices usually involves less risk than when buying at higher prices. This might sound a bit strange, but here me out, if we pay less for something, we are risking less for the same amount of upside. Usually people would think that buying during dips may be more risky, but this may be more due to market sentiments and the thoughts of other people influencing theirs, which is usually what leads to the scenario of low prices and attractive investments.

This leads us to wonder about the change in market sentiment. Sometimes these may actually be justified. While we have not reached the state of an "efficient market", where it is impossible for an investor to outperform the market average, however, most movements in the share prices can be explained (referring more to larger cap shares and for larger movements, which can't be easily influenced by one person making a large trade), maybe through a short-term deprovement in the business environment or other factors that may have an influence on the investment, such as a change in interest rates.

But then these changes may have led to share prices that overcompensate for them. For instance, I read this example in Security Analysis or Common Stocks and Uncommon Profits, that the presence of a good management is usually overcompensated. Good management can be seen in the growth and improvement of the financial statements, however, the growth (brought about by the management) leads to expectations of further growth, which may not be possible to fulfill as the improvements made have already materialised. A positive piece of news may lead to a spiral upwards while a negative piece of news may lead to a spiral downwards.

This is where we can come into the picture. We have to look at the value of the share rather than where we think it's trending. I usually pay more attention to shares that have dropped recently, but also note that when doing this, we need to look out for the information that could have led to the fall and analyze whether the market has overcompensated for it, which would provide us with an opportunity. Of course, there are instances where the price has gone up and the market has under compensated for the good news for the company and so the share continues growing even higher after that.

To conclude, I think that dips in share prices are things that we should look out for, but just blindly buying at the dips may not yield the expected results. We still have to do our own analysis to pick out the good shares that have overcompensated for bad news and sell those that have overcompensated on the good ones.

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  1. Buying at dips are generally good. But cheap can always become cheaper. Hence it is always good to be cautious and have a stop loss in place in case it keeps going down.

    1. Hi investing wolf,

      Agreed, we also have to be cautious about the shares that we are investing in at the dips as well :)