How to Manage Risk When Timing the Market
One common advice for investors is to ‘buy the dips,’ which means purchasing an asset, usually a stock, when its market price drops. This strategy aims to buy stocks at lower prices, potentially leading to higher investment returns.
Buying the dip involves trying to predict how the market will move and making decisions based on these predictions. This differs from buy-and-hold investing, where you buy assets and hold them for a long time, expecting gains over the long haul.
Market timing, like buying the dips, can be tricky and risky. It doesn’t usually work for most investors, even professional ones. However, those who succeed in timing the market can potentially earn significant profits.
Buying the dip means aiming to buy stocks when their prices fall, believing they will go up again.
Stock charts might show smooth lines, but in reality, stock prices move up and down a lot. These ups and downs are the dips and peaks. If you buy stocks after a temporary dip, when they're set to go up again, you might make more money compared to buying them when they're at a peak.
For example, in 2020, 3M, a company owning brands like Ace and Scotch, saw its stock price drop from ₹153.02 to ₹124.89 in March due to the health crisis. As the market improved, its price went up, but there were still times when it dipped again. Investors who bought when it was low might have made profits when the price went up later.
Every time a stock's price drops, it offers investors a chance to buy shares at a lower cost, which can boost their potential profits.
For instance, the stock stayed around ₹145 per share in April, fell to ₹138.69 in mid-May, and then climbed to ₹167.41 in early June. This trend repeated multiple times, and by March 15, 2021, the stock price was ₹189.48.
Buying the dips involves guessing how a stock’s price will change ahead. If you think a stock will keep going up after a drop, buying shares at a lower price might seem like a good deal. But if the stock keeps falling, you've bought when the price was still high, risking a bigger loss.
This method of investing—trying to buy low and sell high instead of holding for a long time—is risky. It could lead to making more money if you’re right, but it's hard to time the market correctly. There's a chance of losing money too. Market timing also tends to cost more in fees compared to long-term investing, so the profits from your active trading must cover these fees to be worthwhile.
Purchasing during market dips is a strategy supported by traders, especially in trendy industries or stocks. This approach becomes trendy during bull markets, where the market's overall upward movement has occasional drops in stock prices.
Purchasing stocks when their prices drop can be risky, mentioned Walter Russell, President and CEO of Russell and Associates. He suggested an alternative strategy called dollar-cost averaging, where regular contributions are made, similar to 401(k) plans, helping to buy during market downturns.
Russell highlighted the risk involved in buying dips, stating that if prices keep falling, investors may not see profits for many years, making it a risky choice.
However, according to Andrew Wang, managing partner at Runnymede Capital Management, there are ways to succeed. Wang advised identifying the reason behind a stock's decline: whether it's part of a broader market trend or specific to the company. He emphasized the importance of choosing stocks with solid fundamentals and good value when buying dips. The key risk, Wang cautioned, is investing in a declining stock that could continue dropping, particularly avoiding stocks that might face bankruptcy.
An alternative method for long-term investing is dollar-cost averaging, a strategy that avoids emotions in investing decisions.
Here's how it works: You regularly invest the same amount of money in the market, regardless of whether the prices are high or low. For instance, you might choose to invest ₹100 each month.
The goal of dollar-cost averaging is to spread out your purchases over time. Sometimes you'll buy stocks when prices are high, and other times when they're low. But since you invest the same amount regularly, you'll buy fewer shares when prices are high and more when they're low. This helps in owning more shares bought at lower prices.
Compared to timing the market, dollar-cost averaging is simpler. You don't need to constantly watch stock prices. All you have to decide is how much to invest and how often you want to buy shares.
Several brokerages offer the option to schedule regular investments automatically, simplifying the investing process.
Investing in the dip means trying to predict when stocks will drop in price and buying them in hopes of selling at a higher value later. It sounds good, but it's hard to predict accurately. Instead, most people do better with a long-term strategy like dollar-cost averaging, which is easier and less risky for most investors.
You can use the "buy the dip" strategy for cryptocurrencies, much like you do with stocks or other investments. Just place a purchase order when the crypto price drops. However, crypto markets tend to be more volatile than traditional stocks, so what's considered a significant dip for a stock might be a regular move for a cryptocurrency, like a 10% drop.
Successfully buying the dip is really tough, just like other strategies based on timing the market. You can use momentum indicators to understand how strong the price moves are, whether up or down. Also, it's smart to look at long-term trends. For instance, if short-term indicators show that prices have dropped a lot and it's part of a long-term market going up, it might mean it's a good time to consider buying the dip.
