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Date Posted: Monday, November 29, 06:06:37am
Author: cathch a falling knife
Subject:

Buying on the dips
by Andrew Page
posted on Nov 24 09:42am
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Andrew PageObsess over small and ultimately insignificant fluctuations if you must, but your efforts are highly unlikely to offer any real reward. As always, your primary focus should be the asset itself, and its longer term prospects.Lately there has been a lot of talk about 'buying on the dips', but what does this mean and does it really offer any practical guidance for investors?

Many market commentators are advising investors to 'buy on the dips', and indeed in upward trending markets this certainly seems to be a wise policy. However as with so many market 'truisms' 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, with a continuing adherence to the dominant trend.

After all, if the price didn't soon recover it wouldn't be a dip! But here lies a real problem; it is by definition 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? This is critical if you are to take real advantage of the move.

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?

The real problem though is that many investors often miss out on far better longer term gains because they are too focused on short term price volatility. In other words, the focus is on the price, not the asset itself, and many can forego significant gains because they end up waiting for a pull back that never comes (or by misreading it when one does come along). Moreover, investors often overate the significance of a minor pull back to longer term returns.

If you like a company and it is currently trading at a price that offers reasonable value, why wouldn't you just buy it now? 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. After all, as with any strategy based on timing short term volatility, things could just as easily go against you.

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, and give the wheel a spin.

On the other hand, if you are looking for a longer (and more fulfilling) relationship, particularly with a company which 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 so what; it certainly hasn't proved to be a bad investment decision. Since then, I have received $5.15 in dividends per share (that's a total yield of almost 60%) and I have an average annualised total return of 21% (that's 21% every year since 2001). Had I managed to time the dip correctly, I would instead have experienced 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 so such an exercise is largely useless. Investing in the market is not about accurately timing price swings (that's trading, and that's totally different). What matters is that you gain ownership, at least in part, to a highly profitable business, and at a price that represents real value. If we are honest and accept that valuation is beset with subjective biases, altering your entry price by a few percent is hardly going to significantly change the outcome. It certainly won't turn a losing trade into a highly profitable one.

So obsess over small and ultimately insignificant fluctuations if you must, but your efforts are highly unlikely to offer any real reward. As always, your primary focus should be the asset itself, and its longer term prospects.

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All recommendations are provided without consideration of any specific reader's investment objectives, financial situation or particular needs. Those acting upon such recommendations do so entirely at their own risk.

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