How to “Safely” Buy the Dip
Falling markets can provide us with great opportunities if we buy the dip. But this comes with extreme risks. What if the price keeps dropping? And instead of buying “the” dip, we end up catching a falling knife?
Here are a few things to consider when trying to “safely” buy assets that are on sale.
1. Make sure the investment has good fundamentals
Warren Buffett is a big fan of the “margin of safety” principle. Here, buying an asset at a discount to its intrinsic value provides a safety net.
If the price of an investment is below its theoretical worth, we assume the price will eventually catch up.
But here’s the problem: there are many ways to define the intrinsic value of an asset. This means that most analysts will have different views on the true worth of an investment.
With that being said, it is far safer to buy a quality asset at a discount than a bad one.
This is where good fundamental analysis helps.
2. Keep some spare gun powder just in case
Don’t fire all your bullets at once, for you might run out of ammunition.
Even if an investment is trading at a large discount, it can still get a lot cheaper. This is because the market can stay irrational much longer than you can stay solvent!
That said, dollar-cost averaging could be an option.
3. Look for technical confirmations to buy the dip
Simple technical analysis can help us decide whether a downtrend is more likely to reverse. If the chart still looks awful, it’s usually better to hold off.
Personally, I like to at least see some sort of W bottom reversal pattern with Bollinger Band confirmation before trying to buy the blood. This is because “W bottoms” are a lot more common than “V bottom” reversals.
It’s also good to wait for the price to get back above the 21 exponential moving average, and for that to get an upward slope.
Here’s a chart to show two “safer” bitcoin entries after large corrections:
4. Buy the dip but watch out for bull traps
Bull traps occur when the price bounces strongly after a big drop. When the price bounces, always pay attention to how it reacts at the key Fibonacci retracement levels.
If the bounce gets rejected before the 0.618 Fib, that’s usually bad. And if the price holds above the 0.618 Fib level, that’s usually good.
Below are two examples of Bitcoin bull traps where the bounce was rejected at the 0.618 Fib level:
You can learn about Fibonacci retracements here.
Buying the dip can lead to good profits over time. But blindly going all-in on every big correction is risky business. As with all things trading and investing, it’s best to have a plan.
The usual disclaimer: nothing you read here is investment advice.